You are here

To see where euro's headed, take a look at where dollar has been

The clamor to borrow in euros this year puts the shared currency on a path familiar to foreign-exchange traders.

[LONDON] The clamor to borrow in euros this year puts the shared currency on a path familiar to foreign-exchange traders.

Global companies have taken advantage of record-low borrowing costs to raise an unprecedented 157 billion euros (US$173 billion) via bonds in 2015. As they start to repay the debt, that will unleash pent-up demand for euros, just as a jump in dollar issuance at the end of the last decade is now boosting the greenback, according to money manager and former International Monetary Fund economist Stephen Jen.

"The euro seems to be heading in the same direction as the dollar after the crisis in terms of structural shorts," said Jen, founder of London-based hedge fund SLJ Macro Partners LLP.

"This will provide support for the euro three to five years down the road."

For the rest of this year, the euro is headed lower, and the recovery won't gather pace until 2017, according to strategists. Median forecasts in Bloomberg surveys put the 19- nation currency at US$1.05 at the end of 2015, before an advance to US$1.06 in 2016 and US$1.11 the following year.

The euro traded at US$1.0985 as of 8:21 am London time on Monday, after a 20 per cent slide that started in May last year.

The key reason for the single currency's decline is the policy divergence between the US and Europe. While the European Central Bank has pledged to keep pumping cheap cash into the economy until late 2016, the Federal Reserve is preparing to raise interest rates from an all-time low, possibly as early as September.

That's the reason companies can borrow in euros more cheaply than ever before, with the cost to issue debt falling to a record 0.85 per cent in March, Bank of America Merrill Lynch indexes show.

The increase in borrowing will be a catalyst for the eventual gain in the euro once the ECB ends its bond-purchase program and starts to raise its benchmark rates, said Jane Foley, a currency strategist at Rabobank International in London.

"The market seems to be underestimating structural tailwinds that could underpin the euro in the longer term," said Ms Foley, whose bank is less pessimistic than most, forecasting a drop to US$1.07 this year. "While the rate- differentials story will drive the euro lower against the dollar in coming months, there are factors that may limit the euro's downside."

So far, the euro is following the greenback's playbook. The Bloomberg Dollar Spot Index fell about 15 per cent in the two years from February 2009 after the Fed cut official rates and pumped money into the economy following the financial crisis.

A jump in dollar borrowing around this time also contributed to the losses by putting more money into circulation. Sovereign and corporate entities outside the US now owe a record US$9 trillion, according to the Bank for International Settlements.

SLJ Macro's Mr Jen said repayments on this debt will lead to years of appreciation in the dollar, which has strengthened against every major currency since the middle of 2014.

BlackRock Inc - the world's biggest money manager - Blackstone Group LP and drug maker Eli Lilly & Co are among US companies that have issued bonds in euros for the first time this year, data compiled by Bloomberg show. Loans in the single currency also increased, with non-bank companies outside Europe owing 1.3 trillion euros as of last September, up almost 5 per cent from a year earlier, according to the BIS.

For Peter Rosenstreich, head of market strategy at Swissquote Bank SA, these structural shorts in the euro may boost the currency sooner than others suggest.

Borrowing cheaply in one jurisdiction to fund the purchase of higher-yielding assets elsewhere is known as the carry trade, and the deals tend to undermine the funding currency when they're implemented and strengthen it as they're reversed.

"What's happening to the euro now is a classic case of a carry trade," Mr Rosenstreich said from the Swiss town of Gland, near Geneva. "And with carry trades, you go up an escalator but down a slide. When risk aversion arises, people will unwind those positions as fast as they can."