There’s been a sea change in investor attitudes toward the euro in recent months. In 2012 concerns about the perilous finances of Greece, Spain, Italy, Portugal and Ireland meant that when the market turned against riskier investments, traders bailed out of the euro. But this year when investors fled risk in emerging markets, many turned to the single currency as a safe haven.
“The euro is certainly behaving with some safe-haven properties,” says Jane Foley, senior currency strategist at Rabobank International in London. “It is quite a dramatic change given where we were two years ago, in the middle of the euro crisis.”
However, there’s a lot of debate among currency traders about what exactly constitutes a safe haven. For some, the classic safe haven is the Swiss franc because Switzerland is politically stable, it has a consistent current-account surplus, its government manages the budget well, and the country maintains an open door for foreign capital.
Others point to the fact that the U.S. dollar is considered the largest safe haven, even though the U.S. runs a current-account deficit and has lost its triple-A credit rating. Their reasoning: The liquidity of the dollar trumps everything else in times of crisis, and U.S. Treasuries’ popularity among reserve managers finances the budget deficit gap. The Japanese yen is considered a safe haven for similar reasons despite the recent tilt to a trade deficit and the country’s mountainous debt.
Foley believes the euro’s main qualifications as a safe haven are the European Union’s growing current-account surplus — €31.4 billion ($44 billion) in the third quarter of 2013 — and the fact that in July 2012, Mario Draghi, president of the European Central Bank, pledged to do “whatever it takes” to defend the currency. In addition, after two years of austerity, green shoots of economic growth are beginning to appear in peripheral European countries such as Ireland and Spain, attracting investors.
Emboldened by Draghi’s pledge, investors viewed long-term bonds issued by peripheral European nations as attractive investments when they became jittery about emerging markets last year after the U.S. Federal Reserve Board’s first suggestions that it would taper its bond-buying program, Foley says. Ten-year Spanish government bonds were trading at 4.42 percent last May, when comparable U.S. Treasuries were at 1.90 percent.
Kit Juckes, fixed-income strategist at Société Générale Corporate & Investment Banking in London, agrees that the Draghi put, as the 2012 speech is often called, has meant that when risk increases globally, it no longer has a negative impact on the European currency. “In a model world, when the global economy became a scary place, money would come back from Latin America and Asia and be invested in U.S. dollars,” Juckes says. “Now when money comes back from Turkey, Hungary and Poland, it heads toward the euro.”
Daniel Katzive, New York–based head of forex strategy for North America at French bank BNP Paribas, says that European investors have been accumulating foreign assets and when they reduce those positions they’re bringing the money home in euros.
Because the ECB has maintained an accommodative monetary policy, the euro is increasingly being used to fund risk positions in the carry trade, Katzive explains. Traders borrow euros at a low interest rate and use them to buy another currency at a higher interest rate. When they exit those positions, they simply reverse the transaction, he notes.
“People think a safe-haven currency means that in a crisis people would run out and buy this currency,” he says. “In fact, after a crisis people have to get out of positions. When things go badly and there’s panic, nobody’s looking for new risk exposure.” The euro is increasingly benefiting from this flight from risk, Katzive adds.
Another factor helping the euro: Developing countries such as China have made a determined effort to diversify their currency reserves beyond the U.S. dollar, making the euro the second-largest portion of many forex reserve funds, Katzive says. To maintain a fixed percentage of those funds in the currency, central banks have been buying euros recently, putting upward pressure on the exchange rate.
Although the euro has clearly profited from all of these measures — it stood at $1.377 in early March, up 1.4 percent from December — none of the three analysts expects its strength to last, and they all forecast a decline in the euro-dollar rate by year’s end.
It’s not about safe-haven status but interest rate differentials, they say. The return to economic growth has been much slower in Europe than in the U.S., so analysts expect U.S. interest rates to begin inching up later this year while the ECB seems ready to maintain low rates to help the European economic locomotive keep picking up steam. “We think the ECB will actually have to cut rates in the near future,” BNP Paribas’s Katzive says, though the central bank left them untouched earlier this month. “As a result, the euro will likely be weak.” • •
