In addition to central bank demand and natural structural demand for the euro, European repatriation of foreign assets has been widely regarded as a main contributor to the euro’s resilience, even as the sovereign debt crisis worsened. However, this support might fade as the ability for European banks and companies to continue to repatriate foreign assets is likely to reach capacity.
Furthermore, the lagged effect of the long-term refinancing operation (LTRO)-financed eurozone bank-bond payouts might spark the catalyst for euro outflows, as investors take cash out of Europe when their bond holdings mature, says Jens Nordvig, Nomura’s head of fixed income and FX research.
“There’s about €700 billion worth of bank debt maturing over the next 12 months that has essentially been pre-funded by the cash given to the banks by the LTRO,” says Nordvig, speaking at the Euromoney Forex Forum in London.
Previously, a large proportion of investors would have rolled over their existing bank debt or invested in other European markets, but with the European bank debt as an asset class essentially dead, bond investors will have to find new homes for their holdings.
Yields in core eurozone sovereign debt are too low to attract investors seeking higher returns, while peripheral sovereign bonds carry risks most investors are still unwilling to bear. European corporate debt is a viable option, though this is a relatively small market.
Nordvig expects the upshot of an unattractive European market to be a migration to US dollar credit as European bank debt matures. Even with a leakage of just 20%, €150 billion of euro-denominated debt could be transferred into US corporate bonds.
“This level of negative outflow would be enough to matter at the margin, and if sentiment in the eurozone deteriorates further, these levels of euro-negative outflows could be even higher,” says Nordvig.
Investors could consider short EURUSD as a medium- to long-term trade in anticipation of a gradual decline in EURUSD, as the balance of flows moves towards a more negative bias.