Been in in-tray but just read
Subject: * Why is EUR Not Lower (GS Econ) - Worth a Read.... *
I think this is a really good piece from Research in the Econ Daily – On the desk, we have been asked the question a huge amount of times “Why is the EUR not lower” – The article below analyses portfolio flow data from Aug and Sept and comes to the conclusion that portfolio flows have been supportive of the EUR… Think back to 2008 when, despite the fact that the US economy was the “eye of the storm”, US investors reacted to crisis in the US Financial Sector by repatriating capital back to the US, causing the USD to strengthen… Over August / Sept repatriations by European investors back to Europe (EUR 77.5bn) have by far exceeded selling of European portfolio securities (EUR 25bn) by overseas investors… It is our thesis that this has been the main reason why EUR has been so well supported in Aug / Sept, despite the aggressive sell-off in peripheral bond markets - Adam
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One of the most frequently asked questions in recent weeks and months has been about the remarkable resilience of the EUR in the face of a substantial sovereign debt crisis. With balance of payments data that covers the crisis period now becoming available, it appears that repatriation flows have supported the Euro in recent months. Similar patterns were observed during the US credit crisis at the end of 2008.
Small FX impact of bank repatriation flows
There is a lot of debate among market participants that Eurozone banks are forced to sell overseas assets to help with the balance sheet contraction. While there could always be isolated examples, we and our bank analysts are quite certain that this is not the main driver of FX moves. Banks typically try to avoid holding too much FX exposure on their highly leveraged balance sheets. In fact, the need to sell overseas assets often results from the very fact that foreign currency funding is no longer available at economical rates. In that respect, the very fact that G7 central banks made cross-border funding available for foreign financial institutions is indirect evidence of how strongly banks typically try to avoid FX mismatch in their balance sheets.
The latest balance of payment data covering the two first months of this year’s sovereign debt crisis shows that banks have repatriated a substantial amount of overseas bond holdings (Aug: EUR17.5bn, Sep: EUR11.1bn), but relatively fewer equity investments (EUR10.3bn and EUR1.0bn). With the relatively larger fixed income investments particularly likely to be fully FX hedged as explained above, the currency impact of these flows was likely very muted.
Larger FX impact of investor repatriation flows
Using the same portfolio data to look at repatriation flows from non-bank investors, it becomes clear that the unwinding of equity holdings was much more dominant (EUR28.5bn in August and EUR10.4bn in September) than the unwinding of overseas bond holdings (EUR7.5bn and EUR9.5bn). With hedge ratios typically lower in equity holdings, investor repatriation therefore has most likely been a key support factor during the crisis so far. Even more interesting, there is anecdotal evidence that over the last two years of the sovereign crisis some Eurozone investors have reduced their FX overlays to reduce their EUR exposure. This in turn means that once these overseas assets were unwound, the FX impact would have been even more pronounced.
Smallish Foreign disposals of Eurozone Assets
Of course, when a crisis hits a country or region most investors think in terms of capital flight and hence intuitively assume currency weakness. We have already seen that Eurozone investors have actually repatriated capital in the face of rising risk aversion; this still leaves the possibility that foreign investors have pulled even more investments out of the Eurozone. But again, the evidence does not support this idea.
Total foreign selling of Eurozone portfolio securities in August and September amounted to EUR25bn, which compares to repatriations by investors based in the Eurozone worth some EUR77.5bn.
Moreover, given the stress seen in the Eurozone over the last two years, it is quite likely that more and more overseas investors in the Eurozone had started to hedge their FX exposure. Persistently large skew in FX option markets support this hypothesis. Therefore the disposal of the underlying Eurozone assets would not have an incremental effect on the Euro. Overall, it is therefore likely that repatriation flows were rather Euro positive during August and September. However, what was remarkable in September, was the substantial build-up in short EUR positions at the IMM, one of the fastest increases ever seen.
5. Repatriation Patterns in Late 2008
When looking at the net repatriation flows into the Eurozone during August and September, it is tempting to compare these with the situation in the US during the credit crisis. The data reveals similar patterns during Q4 2008, when US investors liquidated a reasonable amount of investments in foreign bonds and equity, while foreign liquidations of investments in the US were relatively more muted. Indeed, the BBoP (current account + portfolio flows + FDI) recorded one of the smallest deficits in recent years during Q4 2008 and the repatriation patterns in portfolio flows were critically important. Overall, it therefore appears that large and mature economies with a substantial stock of globally invested assets face net capital inflows rather than outflows when hit by a shock. This is different to the typical assumption for small open economies, in which capital markets are dominated by overseas investors and where disposals by foreign investors dominate.
Adam Crook
Executive Director
Securities Divison
Goldman Sachs International |
