Date: 23-10-2013
Source: The Wall Street Journal
Improving Economy Draws Investors as Fed Keeps U.S. Rates Low
The underperforming U.S. economy has produced at least one clear winner: the euro.
The European common currency shot to a 23-month high against the dollar on Tuesday, rising as high as $1.3792 after government data showed the U.S. economy adding fewer jobs than expected last month. Investors also bought European bonds and stocks; Germany’s DAX stock index closed at a record high of 8947.46.
Investors are snapping up the euro zone’s currency, stocks and bonds as a run of weak U.S. economic data has many predicting the Fed will continue its current pace of bond buying well into 2014. Treasury yields, which had climbed when tapering appeared imminent, have tumbled, touching off a new scramble for markets offering bigger payouts.
Despite the U.S. economy’s stumble, there are few clear bets against the dollar in the currency world today. Analysts generally expect the yen to go lower as Japan ramps up its fight against chronic deflation. Emerging-market currencies have proven unstable amid uncertainty about the Federal Reserve’s next move. And while the British pound and Australian dollar have notched gains against the greenback as well, the euro’s trading volumes are far larger, making it easier for investors to enter and exit large wagers on the currency.
Meanwhile, optimism about the euro zone’s economic prospects is growing. Since May, as the region was emerging from its longest recession since World War II, economic data has generally beaten expectations, according to a UBS index that tracks forecasts. U.S. data has disappointed over the same period, the bank said.
Additionally, fears that the euro zone’s debt problems will rekindle have eased. The European Central Bank’s promise in July 2012 to backstop euro-zone bond markets defused a crisis that had kept investors on the sidelines. Some say they’re now comfortable chasing returns in countries such as Spain and Italy, which they had dubbed too risky as recently as last year.
“Investors feel a lot more at ease with the situation in Europe,” said Peter Wilson, who helps manage $6.1 billion in global fixed-income investments at First International Advisors, which is owned by Wells Fargo & Co. unit Wells Capital Management. “We don’t think Spain and Italy are going to blow up, and they represent reasonable value in the current interest-rate environment. Many people are happy to hold them for the yield.” Mr. Wilson holds Spanish and Italian government bonds.
At the same time, a stronger euro could pose an obstacle to the region’s recovery. The appreciating currency makes European exports less appealing to foreign buyers and reduces profits for exporters when they convert their overseas earnings back to euros.
“We’re still not very excited about the prospects for a euro-area recovery,” said Scott DiMaggio, director of global fixed-income investments at AllianceBernstein, which manages $445 billion. “There will be a bounce in the data, but they’re going to struggle to achieve high enough growth to decrease their debt burdens. You can only be excited up to a point.”
Mr. DiMaggio has been selling the euro over the past few months. Although he still holds Italian, Irish and Spanish government debt in his bond portfolio, he noted that the yields offered by these bonds are shrinking, which reduces their attractiveness. Italian 10-year government debt yields just over 1.5 percentage points above equivalent Treasurys, nearly the narrowest gap since July 2011.
Investors say the Fed and the European Central Bank will ultimately determine whether the euro’s rally has legs. Many investors still expect the Fed to begin rolling back its bond-buying program next year. That would reduce the supply of new dollars entering the market and cause Treasury yields to rise, attracting investors to the U.S. currency and potentially putting an end to a euro rally, analysts say.
But the Fed may have a longer way to go when it is time to tighten monetary policy. The ECB’s balance sheet is already down 23% since last September, as the region’s banks pay back loans ahead of schedule. It sets its benchmark interest rate at 0.5%, while the Fed holds rates near zero.
The euro zone also runs a current-account surplus, meaning it consistently sells more goods and services than it purchases, resulting in a steady inflow of euros and buoying the currency’s value. In August, the euro zone’s surplus was €17.4 billion ($24 billion), according to the ECB. The U.S. ran a current-account deficit of $39.1 billion in July, the most recent data available from the U.S. Commerce Department.
“The euro’s supported by its growing current-account surplus,” said Shahab Jalinoos, currency strategist at UBS in Stamford, Conn. “Meanwhile, the ECB has done nothing to hinder the euro’s rise. All roads currently lead to a higher euro.”
