Euro Proving No Reserve Asset as Central Banks Shift (Update2)

By Paul Dobson and Lukanyo Mnyanda
Feb. 1 (Bloomberg) -- Investors are pulling cash out of Europe at a record pace as central banks slow euro purchases, jeopardizing its status as a substitute to the dollar as the world’s reserve currency.
Last year, policy makers loaded up on euros, while analysts at Barclays Plc in London and Aletti Gestielle SGR SpA in Milan predicted central bankers would make good on threats to reduce the greenback’s dominance. Now the euro is down 8.4 percent since Nov. 25 in its fastest slide in 10 months amid concern that cash-strapped countries like Greece won’t pay their debts.
Billionaire investor George Soros said Jan. 28 that there’s "no attractive alternative" to the dollar.
Traders have spurned European stocks in favor of shares elsewhere for a record 19 straight weeks, "clearly hurting"
the currency by draining a net $13 billion from the market, said Geoffrey Yu, a UBS AG analyst. Investors are as bearish on the euro as they were when the 2008 financial crisis was pushing them to the dollar’s perceived safety, futures data show. After buying more euros than ever in 2009’s second quarter, central banks pared back, International Monetary Fund data show.
"The euro can fall further," said Neil Mackinnon, a former U.K. Treasury official who is a London-based economist at VTB Capital Plc, the investment-banking unit of Russia’s second- biggest lender. "Sovereign-debt risk will continue to be a key theme," he said. "The stresses created by the fiscal situation in Greece won’t go away quickly."

Worst Since Inception

Without specifying a timeframe, Mackinnon predicted the euro will weaken to $1.20. If it finishes 2010 at that level, the year’s 16.2 percent loss would be the worst since the currency’s 1999 inception. The currency fell to an almost seven- month low of $1.3853 today, before trading at $1.3905 as of 9:21 a.m. in London.
In addition to concerns that the European Union will have to bail out Greece, speculation that growth will lag behind the U.S. and Japan and that the region’s debt load won’t return to pre-crisis levels for at least five years also are weighing down the euro, as well as assets denominated in the currency.
The Dow Jones Euro Stoxx 50 Index is among the world’s worst-performing primary equity gauges this year, dropping 9.4 percent in dollar terms, 2 1/2 times the Standard & Poor’s 500 Index’s loss.
The euro region’s economy will expand 1.2 percent this year, compared with 2.7 percent in the U.S. and 1.35 percent in Japan, median analyst estimates compiled by Bloomberg show.

Default Swaps

The cost of protecting $10 million in debt from 15 European governments for five years hit a record $91,060 a year last week, about double both September’s cost and the current price for insuring U.S. debt, data compiled by Bloomberg show. Prices for Portugal, Iceland, France, Greece and Germany swaps have risen the fastest in the world this year and are up about 55 percent on average, the data show. Greek debt insurance is now the developed world’s most expensive at almost $400,000.
"Greece is the catalyst, but it goes to the root of the entire structure of the euro," said Adnan Akant, who helps oversee $39 billion as head of foreign exchange in New York at Fischer Francis Trees & Watts. "The U.S. and Asia are likely to outpace Europe in the economic recovery. That’s reason enough"
to bet against the euro, he said.
At last week’s annual World Economic Forum in Davos, Switzerland, New York University Professor Nouriel Roubini said Europe’s fiscal woes are creating "a rising risk" that its single-currency alliance will splinter.

Pessimistic Roubini

"Down the line, not this year or two years from now, we could have a breakup of the monetary union," Roubini, who predicted the financial crisis a year before it began, said in a Bloomberg Radio interview on Jan. 26. Speaking to Bloomberg Television at the same event, Soros said the euro’s "problems"
make it an unviable substitute reserve currency.
The euro has fallen against each of the 15 most-traded currencies except Brazil’s real this year, dropping 5.6 percent versus the yen and 1.3 percent against the pound. The Euro Index, which tracks the currency versus the dollar, pound, yen, Swiss franc and Swedish krona, has fallen 3 percent in three weeks, its worst run in a year.
While the median Bloomberg survey forecast sees the euro appreciating to $1.42 by Dec. 31, that estimate has dropped five cents in seven weeks. Last year’s most accurate euro forecaster, UniCredit SpA in Milan, sees it losing 0.5 percent. Investors and analysts in Western Europe’s largest nations see the euro’s tumble continuing, a poll of Bloomberg users found last month.

Trichet’s Fuel

European Central Bank President Jean-Claude Trichet’s resistance to printing euros to revive growth fueled a nine- month, 21 percent rally versus the dollar that ended Nov. 25.
The Federal Reserve cut its interest benchmark to as low as zero and created new money to fund purchases of $300 billion in Treasuries and $1.25 trillion in mortgage-backed securities. The ECB didn’t start cutting its target rate until October 2008, more than a year after the Fed, stopped at 1 percent and committed 60 billion euros to buy covered bonds to boost an economy that’s almost as big as the U.S.’s.
"This is a historic moment -- the start of debasement of the world’s reserve currency," said Alan Ruskin, a Royal Bank of Scotland Group Plc currency strategist in Stamford, Connecticut, in March, four weeks after the dollar began plunging. Ruskin couldn’t be reached by phone or e-mail last week.

Diversification

Central banks that disclose currency breakdowns bought a record $60 billion worth of euros in 2009’s second quarter, more than half of their new foreign reserves in that period, according to IMF figures adjusted for exchange-rate changes using a methodology developed by Barclays Capital.
The purchases prompted speculation that U.S. attempts to spend itself out of the worst global recession in six decades would prompt policy makers worldwide to continue diversifying away from the greenback.
Instead, they reversed course, putting 15 percent of new reserves, or $17.8 billion, into euros in the next three months, the smallest share for any quarter in which policy makers’
reserves grew since early 2008, the adjusted IMF data show.
Central banks put 45 percent, or $52 billion, into dollars in the third quarter, up from 36 percent, according to the data.
They had a record $7.5 billion in reserves as of Sept. 30 and disclosed currency breakdowns for 59 percent, IMF figures show.

Cash Flows

Investors are following central bankers’ lead. Those outside the euro zone sold a net 3.9 billion euros of the region’s equities, bonds and money-market securities in November, the first monthly outflow since July, ECB data show.
Europe-based investors bought a net 11 billion euros of such securities from outside the region, the second monthly increase.
Money has flowed into U.S. stocks for 15 straight weeks, according to Yu, the London-based analyst for UBS, the world’s second-largest currency trader.
Debt in the region’s economies will swell to 84 percent of gross domestic product this year, from 66 percent in 2007, the year credit markets began to seize up, according to the European Commission. The U.S.’s debt will be 60 percent of GDP this year, according to the Congressional Budget Office.
Eight of 11 euro-area finance officials surveyed by Bloomberg in December said it will take at least until 2015 to bring debt sales down to where they were before Lehman Brothers Holdings Inc.’s collapse in September 2008 sparked the global financial crisis. Four predicted as much as a decade.

‘Anti-Dollar’

"Central banks are looking at ways of buying something other than euros," Akant said. "The euro has been overvalued.
Its best days were always as an anti-dollar trade, and now it’s losing that status."
Werner Eppacher, who oversees $15 billion a year in trades as head of foreign-exchange at DWS Investment GmbH in Frankfurt, said investors outside Europe are "overreacting" to the euro’s drop.
"The euro is cheap at current levels," Eppacher said.
"We will use this emotional market environment to build up euro long positions. Sooner or later the negative news will be priced in, and then you have the best opportunities to buy the euro against currencies like dollar and yen and sterling."
The current slide will help European exporters, Eppacher said. Companies listed in Europe’s Dow Jones Stoxx 600 Index get
35 percent of their sales from outside the continent, according to Bank of America Merrill Lynch.

‘After the Storm’

Fabrizio Fiorini, Aletti Gestielle’s head of fixed income, said he stands by his prediction of a "gradual decline" of the dollar. "I don’t expect these problems in Europe will be important for a long time," said Fiorini, whose company oversees $10.5 billion. "After the storm, we can regain the dollar weakness trend."
The euro’s losses began in November, the month after Greek stocks and bonds started tumbling as Prime Minister George Papandreou’s socialist government came to power. When the country’s 2009 budget deficit approached 13 percent of gross domestic product, Standard & Poor’s, Moody’s Investors Service and Fitch Ratings downgraded its credit in December.
The yield premium investors demand to hold Greek 10-year government bonds over German bunds widened to almost 4 percentage points last week, the most since the year before the euro’s 1999 introduction.
Investors are concerned a default by Greece would create a "vicious circle" of contagion in Europe, said Jim Reid of Deutsche Bank AG. Greece’s outstanding debt totals 254 billion euros, compared with Russia’s 51 billion euros before it defaulted in 1998 and Argentina’s 57.2 billion euros when it missed payments in 2001.

No Such Thing

"Greece will not default; in the euro area, default does not exist," European Monetary Affairs Commissioner Joaquin Almunia told Bloomberg Television on Jan. 29 at the Davos forum.
The day before, Trichet said he’s "confident" that Greece will take the right steps to reduce its deficit.
All euro economies this year will breach the EU’s budget- deficit ceiling of 3 percent of gross domestic product, the commission predicts.
If continental authorities don’t "step up their efforts to restore confidence" soon, investors "could start questioning the long-term strength of the euro," said Michiel de Bruin, who helps manage about $28 billion as head of European government bonds in Amsterdam for F&C Asset Management.
Hedge funds and other large futures speculators had almost 73,000 bets that the euro will fall last week, more than twice the number of wagers that pay off on a rise, data from the U.S.
Commodities Futures Trading Commission in Washington show.
That’s the most bearish sentiment since October 2008, when the currency weakened 9.7 percent the month after Lehman’s collapse.

Delayed Rate Increases

Futures show investors expect lagging euro-region growth will delay the ECB from increasing interest rates, making the currency less attractive relative to cash from economies with higher borrowing costs. The yield on the three-month Euribor futures contract for December fell to an unprecedented 1.425 percent on Jan. 26.
European policy makers will keep their benchmark rate near its current record low 1 percent until the fourth quarter, while the Fed will abandon its near-zero rate in the third, median forecasts show.
"The first part of this year, three or four months, will see the euro decline because of the anticipation of the Fed moving sooner," said Thanos Papasavvas, who helps manage more than $5 billion in currencies at Investec Asset Management Ltd.
in London.

Unemployment Surprises

Following a Dec. 4 Labor Department report that the U.S.
lost more than 100,000 fewer jobs in November than economists forecast, "we took off quite a bit of our euro-overweight position," Papasavvas said. The dollar surged 1.3 percent against the euro, the most in about six months, after the jobs report.
Last month, the U.S. reported that unemployment was unchanged in December at 10 percent, and the EU said the euro- region’s rate increased to 10 percent that month. The U.S. rate for January, due for release Feb. 5, also won’t change, the median forecast shows.
Stuart Thomson, who helps oversee $100 billion at Ignis Asset Management in Glasgow, Scotland, started selling euros last month after being bullish on the currency last year. He sees it falling to about $1.25 in the next 12 months. "This is one of those years for the dollar to smile," he said.