Here are three myths about European FX flows.
1. The current account surplus is large, so the euro can never drop. It is true that the Eurozone has built up a chunky surplus. But if that makes it bullet-proof, how can one explain the +30% weakening episodes in the yen in the 00s even as the current account swelled to above 10% of GDP? Or the pre-crisis run-up in EUR/CHF to 1.60 under a 15% surplus? We think the message should be that it’s not just the current account that matters, but the interaction with portfolio and other investment flows.
2. European flows are becoming “Japanified”. It is true that repatriation into the Euro-area has been large. But the vast majority of this has been due to banks de-leveraging foreign assets, which we don’t think has a big impact on FX because these assets are funded offshore. Indeed, stripping out bank flows does a much better job of explaining EUR swings than the total portfolio flow numbers (please ask for charts if interested). And when looking at “pure” European outflows, they are running at a similar pace as they were pre-crisis – Europeans aren’t turning Japanese just yet (chart 1).
3. Equity inflows are unstoppable. Foreign equity inflows into the Euro-area have been extremely strong, almost half a trillion euros since the start of 2012! But at least the January portfolio flow data released last Friday should give some food for thought. Non-bank foreigners liquidated the largest amount of European equities in more than two years, the first month of sales since Draghi’s “whatever it takes” speech. In contrast, Europeans continued investing offshore, turning net equity flows negative. So there may be evidence that foreign appetite for Euroland equities is saturating. Taken together with the euro’s increasing attractiveness as a funding currency given the ongoing re-pricing of US rates, we would argue the euro flow picture is not as supportive as the popular narrative suggests.
Read the full report: FX Daily
DB