Euro plunge to parity derails as Draghi cash flows into equities

[NEW YORK] After its biggest slide since being created in 1999, the euro is finding a floor.

A torrent of money unleashed by the European Central Bank is fuelling demand from US and other international investors for the region's stocks - and the currency needed to buy them. Global mutual funds and exchange-traded funds that focus on European equities attracted US$63.6 billion this year through April 22, up 70 per cent over the same period in 2014, according to data compiled by EPFR Global.

Rather than a referendum on the outlook for growth in the euro zone, demand for the 19-nation currency reflects appetite from investors who want a piece of this year's 19 per cent rally in the region's stocks.

"European equities went from being an incredibly unloved asset class to very fashionable almost overnight," David Donabedian, the Atlanta-based chief investment officer at Atlantic Trust Private Wealth Management, which oversees US$26.2 billion, said April 23. "In the short term, the euro will probably firm a bit more."

Demand for the region's equities has driven the Stoxx Europe 600 Index to a record since ECB President Mario Draghi announced his quantitative-easing plan on Jan 22. The gains mirror the reaction during the Federal Reserve's third bond- buying program, which ran from September 2012 to October 2014 and sent US stocks higher. The dollar strengthened about 10 per cent in that time.

Some money managers are forgoing currency hedges on their European investments, Nomura Holdings Inc. analysts led by Jens Nordvig wrote in an April 17 note.

About 30 per cent of the US$25.5 billion channeled into U.S. exchange-traded funds focused on European equities went into unhedged strategies, according to data compiled by Bloomberg. That US$8 billion is about comparable to the entire amount that was invested in the same period of 2014 across both hedged and unhedged ETFs with a similar focus.

"If you're a North American investor, we finally have QE, we finally have policy makers responding," Susanne Alexandor, a senior member of the investment team at Cougar Global Investments, a Toronto-based investor in ETFs with $1.3 billion under management, said April 21. "We like the market and we decided to take the currency unhedged because we don't have huge conviction that the euro could go a lot lower from here."

After tumbling from almost US$1.40 in May 2014, the euro is poised to rise in April for the first time in 10 months. It was at US$1.0862 at 11:30 am in Tokyo, up from US$1.0731 at the end of March. Since March 6, it has closed in a five-cent trading band between US$1.0496 and US$1.0970.

Cash has exited the euro region as ECB bond-buying took debt securities out of the market, sending yields below zero. About 135 billion euros (US$147 billion) flowed from the region into foreign portfolio assets in the last three months of 2014, according to Deutsche Bank, about 90 per cent of which was attributable to fixed income.

While some of that money is returning to the continent's stock markets, investors such as Philippe Brugere-Trelat of Franklin Templeton wonder whether that is enough to turn the tide for the shared currency.

"There is a modicum or degree of support coming from inflows into euro-denominated equities, no doubt about that," Brugere-Trelat, a money manager for the Franklin Mutual Series in Short Hills, New Jersey, which manages US$74 billion of assets, said April 23. "But the fixed-income flows out of the euro are much higher."

Deutsche Bank forecasts at least 4 trillion euros will leave Europe during the next few years, weakening the currency to parity by January and to 85 cents by 2017, according to a report last month. Barclays Plc, Citigroup Inc. and Morgan Stanley all project the currency will fall below parity by Dec. 31. The median estimate more than 60 analysts surveyed by Bloomberg is for a year-end level of US$1.04.

"There's always been this belief that the euro needs to come down to parity if growth is really to take hold," Quincy Krosby, a market strategist in Newark, New Jersey, at Prudential Financial, said April 21. "Initially, quantitative easing helps boost asset prices, but then the question I think remains how much really can it do in terms of generating growth." Prudential Financial oversees more than US$1 trillion in assets.

Better-than-forecast reports on European manufacturing, industrial production and retail sales have pointed to an improving outlook in recent months. The economy is poised to grow at the fastest pace since 2011.

"Europe is surprising on the upside," Robert McAdie, head of research and strategy at BNP Paribas SA, said in New York April 15. "If European growth continues to pick up, you'll see the inflows going into Europe - like portfolio inflows - which will support the euro."

BLOOMBERG