The euro’s 25% jump against the yen over the past six months underscores the rising pressure on European Central Bank President Mario Draghi to cut interest rates as the region’s exporters lose out to Japan.
Futures traders are adding to bets that the ECB will lower its benchmark rate in the months ahead to weaken the currency, while economists now predict a quarter-point reduction at next week’s policy meeting. Even that may not be enough to stoke “real growth,” said Bill Gross, who runs the world’s largest bond fund at Pacific Investment Management Co. He expects a drop in the euro and advised investors yesterday to sell.
Draghi’s dilemma is that while his pledge last year to keep the currency union intact succeeded in boosting confidence, it also contributed to a euro so strong that it’s hurting competitiveness. A report showed that German business confidence fell for a second month in April, after data yesterday indicated euro-area services and factory output shrank for a 15th month.
“Draghi is aware of the slowdown we’re starting to see,” said Gavin Friend, a currency strategist at National Australia Bank Ltd. in London and the most accurate forecaster on the euro versus the yen in the first quarter. “Now we’re getting negative on the euro zone and negative on the euro. The market is starting to look toward the next meeting and the prospect of a rate cut. It’s going to be volatile from here on.”
Carmakers Slide
Economists watch the euro’s exchange rate against the yen because some of the region’s biggest exporters, including carmakers Daimler AG of Germany and PSA Peugeot Citroen of France, compete with the Japanese for sales into the U.S. and China.
In a mark of the struggle they face, shares of Toyota Motor Corp., Japan’s biggest automaker, have climbed 40% this year while Daimler’s fell 1.9%. Peugeot Chief Financial Officer Jean-Baptiste de Chatillon said today that exchange rates held back the Paris-based company’s first-quarter revenue by about 2%.
The euro rose 0.1% to 129.37 yen as of 8:27 a.m. in New York, after climbing to a three-year high of 131.12 yen on April 11. Against the dollar, it was little changed today at $1.2996, holding above its 52-week low of $1.2043 in July.
Central-bank officials “have to find ways to avoid that the euro appreciates and actually try to make it depreciate,” former ECB Executive Board member Lorenzo Bini Smaghi said in an interview on “Bloomberg Surveillance” with Sara Eisen and Tom Keene on April 17. While the ECB doesn’t target exchange rates, “they are important for price stability and for growth,” Draghi said on April 19 in Washington.
Draghi’s Pledge
The 17-nation currency has strengthened about 7% versus the dollar since Draghi said July 26 that he’d do “whatever it takes” to protect the euro and the region’s economy. He later outlined a plan called Outright Monetary Transactions in September that allows the ECB to buy short- maturity notes issued by euro-area nations that request aid. No country has activated the plan.
The ECB’s May 2 policy meeting will be its first since the Group of 20 summit in Washington on April 18-19. There, officials failed to criticize Japan for debasing its currency through its monetary policies, prompting options traders to trim bearish bets on the euro against the yen.
Predicting Cut
Futures contracts based on the euro interbank offered rate, a benchmark of how much banks charge to lend to one another, signal increasing expectations for the ECB to lower its main refinancing rate from the record-low 0.75% it has maintained since July. The implied yield on the contract for June was at 19 basis points, close to the lowest since Jan. 2 and down from the high for this year of 42 basis points Jan. 25.
Twenty one of 35 forecasters surveyed by Bloomberg, including UBS AG, Rabobank International and Royal Bank of Scotland Group Plc, now predict the ECB will lower its main interest rate to 0.5% next week.
Five days after the Bank of Japan unveiled an unprecedented stimulus package on April 4, a Bundesbank report showed German exports fell 1.5% in February, more than economists forecast. Germany is Europe’s biggest economy and sells about 40% of its output abroad.
That was followed on April 18 by a Finance Ministry report showing growth in Japan’s overseas sales beat analysts’ predictions by almost 1 percentage point.
“At current levels it’s OK, but if the euro appreciates to 140 yen or 150 yen, then Germany will suffer in terms of exports,” James Kwok, the London-based head of currency management at Amundi Asset Management, which oversees about 727 billion euros, said in an interview yesterday.
Risk Reversals
The premium for six-month options granting the right to sell the euro versus the yen relative to those allowing for purchases fell 10 basis points, or 0.1 percentage point, to 1.25 percentage points on April 22. That’s the biggest move in favor of the single currency since April 11, according to so-called 25-delta risk reversals. The spread has averaged 3.92 percentage points in the last five years.
“Downside risk remains in the euro area and should data continue to disappoint, the ECB is likely to act,” Fiona Lake and George Cole, analysts at Goldman Sachs Group Inc. in London, wrote in an April 19 note to clients.
Strategists are predicting even more euro strength, boosting their forecasts for the currency against the yen by 4.8% in April. Europe’s shared currency will end the year at 130 yen, according to the median of 44 economists’ and analysts’ predictions compiled by Bloomberg. At the end of 2012 they were calling for 109 yen.
Currency Correlations
Correlations in exchange rates show the euro is moving in the opposite direction to the yen more consistently than at any time since the common currency’s 1999 debut. It’s a sign that some of the money flowing out of the yen because of the BOJ’s policies is flowing back to Europe to prop up the euro.
Speculation that Draghi will have to bow to pressure from markets for a reduction in borrowing costs is being stoked by economic data. The Ifo institute in Munich said today its index of Germany’s business climate, based on a survey of 7,000 executives, dropped to 104.4 from 106.7 in March.
A composite index of euro-area services and factory output based on a survey of purchasing managers in both industries by London-based Markit Economics held at 46.5 for April, indicating a contraction, a report yesterday showed. Similar German PMI data also showed a contraction.
“This is not a level that suggests economic growth or a stronger recovery,” said Lutz Karpowitz, a senior currency strategist at Commerzbank AG in Frankfurt, who expects the euro to end the year at $1.28. “The data was pretty bad. Now Germany is also in a range where you wouldn’t expect growth in the near future.”
‘Sell Euro’
Gross, the co-chief investment officer at Newport Beach, California-based Pimco, manager of the $289.1 billion Total Return Fund, agrees with those predicting a rate cut, even if he’s not confident it would have the effect exporters desire.
“Expect an ECB cut soon but will it lead to real growth? Doubtful,” Gross said in a posting on Twitter yesterday. “Euro needs to go down. Sell euro.”
Morgan Stanley analysts said in a report today they were preparing for “a resumption of the major downtrend” for the euro against the dollar, a change of strategy.
The euro is overvalued by 5.1% against the dollar based on an index developed by the Organization for Economic Cooperation and Development in Paris that uses relative costs of goods and services. That’s less than the Norwegian krone and Australian dollar, which are about 36% too strong. The euro is 0.7% too strong against the yen, the gauge shows.
Even a rate cut won’t curb the euro’s strength against the Japanese currency, according to Michael Sneyd, a currency strategist at BNP Paribas SA in London.
“Beyond next week’s ECB meeting, where we are expecting a cut, the euro should start to perform well,” Sneyd said in phone interview yesterday. He predicts the common currency will strengthen to 140 yen by year-end.
