Euro's Surge Shows Power of Carry Trades Unwinding
28 February 2020 - 11:17AM
Dow Jones News
By Paul J. Davies and Anna Isaac
The euro has rallied against the dollar this week, contrary to
what might be expected in a weak economy that has the biggest
outbreak of coronavirus outside of Asia.
Investors have piled into the common currency, driving it 1.8%
higher against the dollar since the end of last week. But they
haven't been buying the euro because they think the eurozone is on
course for a turnaround, or because Europe has suddenly become a
haven for funds when global risks escalate.
In fact, the reason for these counterintuitive market moves,
according to some analysts and investors, is the carry trade:
Investors who were borrowing cheap euros to invest in riskier
assets are now, amid the recent market turmoil, selling those
assets to buy back euros and unwind their trades.
"Markets are not always rational," said Jordan Rochester, a
foreign-exchange strategist at Nomura Holdings. "We have a
situation developing in Italy right now with cases getting higher,
but the euro moving upwards. This is a washout of positions of
carry trades."
Some analysts and investors have been puzzled this year by the
euro's persistent weakness when many of the traditional drivers of
the currency have been improving. The difference between interest
rates in the eurozone and the U.S. has shrunk, which in theory
should make the dollar less attractive. At the same time, the
eurozone has enjoyed growing capital inflows despite its growth
problems.
Since its recent low on Feb. 20, the euro has risen 2.4% against
the dollar to $1.104. It has jumped 5.9% against the rand and 7.8%
against the peso over the same period.
This is similar behavior to currencies more traditionally seen
as so-called havens, which investors buy when the world looks
riskier, such as the Swiss franc and Japanese yen. The franc is up
2% against the dollar since Feb. 20 and the yen is 3.1% higher.
The previous weakness and surprising strength now is in part
likely due to hedge funds selling euros and buying higher-yielding
currencies such as the peso and rand, then reversing those trades
this week. Leveraged investors had been increasing their bets
against the euro in February, according to weekly net exposure data
in futures markets from the Commodity Futures Trading Commission,
which is one indication that they were pursuing such carry
trades.
However, other forms of borrowing in euros by non-European
investors -- through banks or bond markets -- have also surged in
the past few years, according to analysts, which is having a
similar effect on the euro.
However, another important dynamic at play is the end of the
month, when some investors look to balance their books and some
banks call in short-term loans. A lot of this week's euro rally
could be investors closing out bets against the currency, according
to Kit Juckes, a currency strategist at Société Générale.
"The market was clearly short euros and there is very likely to
be buying related to short covering at month-end," Mr. Juckes
said.
Either way, the euro is likely to weaken against the dollar
again next week, according to analysts. Nomura's Mr. Rochester said
the risks to the eurozone are still higher than the risks to the
U.S.
"The euro is a safe haven versus emerging markets, as it has
been a carry-trade funder for some time," Mr. Rochester said. "But
it's not clear to us that this will cause a medium-term move higher
in the euro versus the dollar."
Write to Paul J. Davies at paul.davies@wsj.com and Anna Isaac at
anna.isaac@wsj.com
(END) Dow Jones Newswires
February 28, 2020 06:02 ET (11:02 GMT)
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