Jens Nordvig, head of currency strategy at Nomura, says there is now accumulating evidence of capital flight from the eurozone that could potentially cause the euro to trade much lower. He says phase one of the eurozone crisis, from April 2010 to June 2011, was characterized by foreign investors pulling back on the purchase of peripheral eurozone government bonds.
Phase two began in July 2011, when eurozone debt-market tensions spread to Italy and Spain, and foreign private investors started reducing exposure not only to Italy and Spain but also to Belgium, France and even Germany.
“After a brief period of relaxation in eurozone risk premia and related cross-border flows, induced by the LTRO, we now appear to have entered a third phase of the eurozone crisis, where the capital outflow picture is starting to look considerably weaker,” argues Nordvig.
“The new element, which we are starting to detect, is that domestic investors in the eurozone are starting to push more money abroad, in a dynamic resembling what we previously observed around traditional emerging market currency crises.”
He notes four observations that point to emerging capital flight to foreign assets by eurozone investors.
First, balance of payments data from the European Central Bank showed outsized foreign fixed-income buying by eurozone investors in March – around €50 billion worth.
Second, mutual funds have shown unusually strong buying of foreign fixed income, especially US and EM, in April, May and June. That is unusual since there is normally repatriation of foreign fixed-income assets in a bear market.
| Regime shift in eurozone investor flows - buying of foreign assets in bear market |
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| Source: Nomura |
Third, there has been evidence that the Swiss and Danish central banks have intervened aggressively in May to counter strong inflows.
Fourth, the notion of capital flight from the eurozone is consistent with price action in G10 sovereign bond markets in recent months.
“The capital flow picture in the eurozone appears to have deteriorated further in recent months, with evidence now accumulating that capital flight, by eurozone residents, is the new element,” says Nordvig.
“This new dynamic is EM-like and opens the door to much more pronounced euro weakness, if it continues.”