The euro’s tumble towards $1.30 against the dollar on Tuesday may have looked dramatic, but the single currency – for all the nervousness over the eurozone debt crisis – remains above its January low.
For months, investors have struggled to explain its apparent strength, given the steady stream of negative headlines that have pummelled European equities and the bond markets of Italy, Spain and even France.
One popular theory doing the rounds among currency analysts is that European banks have been supporting the euro by selling overseas assets and bringing the money back home. When that trend comes to an end, the theory goes, the euro could fall sharply.
That fall, say some, has been due for some time if the build-up of net short positions recorded by the US Commodity Futures Trading Commission is any guide. So reported comments by Angela Merkel, Germany’s chancellor, on the funding of the eurozone’s future bail-out fund, if bearish for the euro, could easily push it sharply lower, as happened in European trading on Tuesday.
Yet the evidence for so-called “repatriation” is thin. Analysts admit that rumours from the trading floor and indirect data support their views, but do not prove them. As a result, some are beginning to question whether repatriation is having any effect on the currency market at all.
The argument is based on the observation that European banks need to raise €115bn – at least – to comply with a minimum threshold demanded by bank regulators by next year. A squeeze on funding, in particular US dollar funding, has exacerbated serious concerns over liquidity.
Analysts at Morgan Stanley estimate that European banks will have to shrink their balance sheets by about €2tn over the next two years, in part to comply with tougher capital requirements. Others point to announcements from banks such as BNP Paribas, which have outlined extensive deleveraging programmes to bolster their capital ratios.
But deleveraging does not necessarily lead to repatriation. It is unclear whether banks selling overseas assets are converting the cash from that sale back into euros. For example, Banco Santander sold its Colombian banking arm to CorpBanca last week for $1.2bn, but has declined to say if that money will be converted to euros.
The vast sums traded in the foreign exchange market, with the most recent estimate at $4tn a day, make it hard to say that even deals of a billion pounds are having an effect. Banks, moreover, are likely to fund their dollar assets in dollar liabilities, and the repatriation of any profit from an overseas sale could be minimal.
“We think much of the deleveraging in the last four months has been European banks selling dollar assets to offset the squeeze in dollar funding, which should be net neutral for FX,” says Huw van Steenis, banking analyst at Morgan Stanley.
“The net effect is limited at best,” agrees Geoffrey Yu at UBS, who says that internal flows at the bank show that their investors have been net selling the euro against the dollar for most of the year.
Some point to data from the European Central Bank that show positive net portfolio inflows into Europe in August and September. Balance-of-payments figures show that a net €20.7bn went into the eurozone in September. In August, that figure was €31.9bn.
However, the portfolio inflows this year have been volatile, while the overall financial account, which includes central bank reserves and transactions between banks, is in the same range it has been for years and is even slightly lower recently, points out Citi’s Steven Englander.
“This may mean that eurozone investors are not cutting foreign assets to the degree thought or that they are simultaneously cutting assets and liabilities,” he says.
The fact the repatriation argument has gained traction despite little hard evidence is a symptom of the difficulty analysts have faced in recent months in explaining why the euro is still so strong.
In spite of this week’s fall, amid disappointment over the outcome of last week’s European Union summit, the single currency is still worth the same as it was in January. Various explanations for this have been offered, from central banks diversifying foreign reserves into euros to hedge funds already so short the euro they cannot send it any lower, as well as the difference in the level of interest rates between the eurozone and the US.
Another factor could be the behaviour of overseas investors. For much of the year, investors have simply shifted assets from the peripheral countries to the core. Alan Ruskin at Deutsche Bank points out that net portfolio investment in the eurozone was €7.68tn at the end of June, higher than net euro portfolio investment abroad of €4.67tn.
That leaves the euro vulnerable to any dumping of assets by overseas investors. And there are already signs that this has begun. Credit Suisse points to data this week showing that Japanese investors – huge buyers of European assets – sold Y270bn of foreign assets in November, the largest dumping of overseas securities in six years.
Some analysts insist repatriation – or the end of it – will have an effect on the euro. But, with rating agencies warning that the EU summit has done nothing to alter their negative view on many European countries, trying to explain the currency’s strength might no longer be an issue.