HSBC- EUR: Myths Vs Facts

"We are not convinced by a number of suggestions offered for the EUR’s resilience to wider USD strength. One idea is that EUR is gaining on the basis of its improving current account balance. Yet the US deficit has seen an even greater correction in its imbalance. In addition, the swing into surplus for the Eurozone reflects economic weakness or collapsing domestic demand not strength. The second suggestion is that the EUR is being supported by portfolio flows, but the Eurozone is not the only market to see buying of local equity and bond markets. Furthermore, portfolio flows are not the dominant aspect of the Eurozone’s capital account.

So in the end, the EUR continues to be a “carry trade” where currency movements are largely determined by movements in relative rate expectations. Chart 10, for example, shows EUR-USD in black plotted against the expected gap between Eurozone and US 3M interest rates by the end of 2015. The link may not be perfect, but it is strong. The EUR-USD exchange rate will be determined by the policies of the ECB and Fed, a data-determined evolution, and one we continue to believe will see EUR-USD much lower over this year."

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HSBC: EUR: 'Myth-Buster'

The EUR’s resilience in the face of a dovish ECB has encouraged a mistaken belief that the currency is being dominated by factors other than carry, notes HSBC.

To make the case for that, HSBC challenges two popular arguments, concluding they are not the key drivers of the EUR.

Myth 1: The EUR rise is being driven by the Eurozone’s improving current account balance.

"If current accounts mattered in G10 FX, we would be buying the USD ahead of all others, not the EUR. The US has seen a greater improvement in its current account balance than Europe, yet EUR-USD has risen. In fact, current account developments appear to explain very little about G10 FX during the financial crisis. In any event, the improvement in the Eurozone’s current account reflects weakness not strength. Extending EUR bull logic on this front would unpleasantly imply buying the currencies of any country suffering from a domestic demand collapse," HSBC clarifies. 

Myth 2: The EUR rally is due to rising investments in Eurozone asset markets.

"The renewed appetite for Eurozone assets seems a more compelling EUR bull argument, but Europe is not alone in enjoying fresh inflows into equities. In addition, portfolio flows are not the biggest element of the Eurozone’s capital account, with net foreign direct investment and “other” investment outflows comfortably outpacing net portfolio inflows," HSBC adds.

Where To From Here?

"Beyond these specious myths where the EUR bull is the hero, the reality is that the outlook for monetary policy is now once again the key driver to the EUR and much of G10 FX. The Fed is heading towards the exit for QE, whereas the ECB is likely to ease again. It means the EUR bullish run is likely to meet a tragic end, like all good myths,

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