Euro Supporter Credit Suisse Joins Bears After Rally: Currencies

Jan 02, 2014 3:20 am ET

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Jan. 2 (Bloomberg) -- Credit Suisse Group AG went against the consensus in June and correctly called the euro’s rally. Now, the bull has turned into a bear, with the firm predicting the common currency’s biggest annual drop in almost a decade.

The euro’s appreciation to its strongest levels against the dollar since 2011 will likely be unsustainable as the monetary policies of the European Central Bank and Federal Reserve separate, strategists at the Swiss lender say. Yields on German bunds have fallen to the lowest in seven years relative to U.S. Treasuries, weighing on the 18-nation euro.

“We were bullish on the euro up to now, but as we head into next year, we think the policy-divergence theme is going to dominate” and favor the dollar, Anezka Christovova, a foreign- exchange strategist at Credit Suisse in London, said in a late- December phone interview.

Credit Suisse sees the euro dropping 10 percent in 2014 to $1.24, down from $1.3743 at the end of last year and lower than the $1.28 median estimate of more than 40 analysts in a Bloomberg survey. With the currency trading at about $1.30 in June, the bank forecast a gain to $1.38 by year-end, above the $1.27 median prediction at the time. The euro hasn’t fallen 10 percent or more since 2005.

Sentiment Reversal

The reversal in sentiment at Credit Suisse may suggest that this is the year the euro finally makes good on the bearish predictions of most analysts. The currency soared 8.5 percent in 2013, as measured by Bloomberg Correlation-Weighted Currency Indexes, while the euro zone’s recovery from a sovereign-debt crisis gathered pace. That more than made up for a dovish central bank that cut interest rates to a record 0.25 percent.

Skeptics stung by the rally included John Taylor, the founder of FX Concepts LLC, who called for the shared currency to weaken to parity versus the dollar. New York-based FX Concepts, once the world’s largest currency hedge fund, closed its investment-management business in October.

The euro is primed to weaken as a stronger U.S. economy prompts the Fed to reduce the amount of dollars it prints to buy bonds -- a policy that has restrained the greenback. At the same time, inflation at less than half the ECB’s target will allow that central bank to maintain accommodative policy after cutting rates to a record 0.25 percent.

‘Profound Impact’

“Tapering may change the perception of how the dollar is viewed, especially against the euro,” Daragh Maher, a currency strategist at HSBC Holdings Plc in London who sees the euro falling to $1.28 by year-end, said in a telephone interview. “2014 could be the year when monetary policy moves in opposite direction and this could have a profound impact on the euro.”

Europe’s common currency rose against all of its nine developed-country peers last year, based on Bloomberg Correlation Weighted Currency Indexes, posting its first gain since 2008 as the economy emerged from its longest recession on record. It bought $1.3747 as of 1:09 p.m. in Singapore after climbing 4.2 percent in 2013, the biggest annual gain since 2007.

Greek sovereign bonds rallied 48 percent, the most among 31 sovereign-debt markets tracked by Bloomberg World Bond Indexes. The second-best performer at 12 percent was Ireland, which exited its international bailout program on Dec. 15.

The euro is stronger today than was predicted by all except one of 68 analysts and strategists who submitted forecasts to Bloomberg by the end of June. It gained 5.6 percent between June and the end of December.

Relative Growth

Strategists’ forecasts for a weaker euro come as separate Bloomberg surveys show that the region’s economy will trail the U.S. by 1.8 percentage points on average 2013 through 2015, and lag behind peers in the Group of 10 by 1.1 percentage points.

ECB President Mario Draghi said Dec. 5 that rates will be kept low “for an extended period of time.” Fed policy makers will cut their monthly bond purchases in $10 billion increments over the next seven meetings before ending the program in December 2014, according to the median forecast of analysts surveyed by Bloomberg News. The U.S. central bank said on Dec. 18 it would pare the program to $75 billion a month from $85 billion.

Strategists also see the euro dropping against the yen and the U.K. pound, whose economies are also forecast to beat the $12.2 trillion euro area. The euro region’s economy will trail Japan’s by 0.6 percentage point this year and Britain’s by 1.4 percentage points, according to separate Bloomberg surveys.

Yen, Sterling

The euro will drop about 5 percent to 138 yen by the end of December from 144.77, according to the median of more than 30 economists’ and strategist predictions compiled by Bloomberg. It jumped 26 percent against its Japanese counterpart during 2013. Against sterling it will drop about 3 percent to 81 pence from 82.93 pence, erasing last year’s 2.3 percent gain.

Demand for euro-denominated assets was also buoyed as the ECB’s balance sheet shrank to 2.3 trillion euros ($3.2 trillion) on Dec. 27, from a peak of 3.1 trillion euros in June 2012 after banks repaid almost half the 1 trillion euros of emergency loans provided by the ECB under two longer-term refinancing operations, or LTROs, in December 2011 and February 2012 to avert a credit crunch. The Fed’s balance sheet rose to $4.03 trillion from $856 billion at the start of 2007.

At $860 billion, the gap between the assets of the central banks is the most since member states formed the ECB in 1998 and introduced the euro in 1999. Latvia became the 18th member yesterday.

Fading Support

Whatever support the euro got from a smaller ECB balance sheet will fade in the second half as policy makers maintain accommodative policy and the Fed “begins to more meaningfully stabilize its balance sheet,” according to Robert Sinche, global strategist at Pierpont Securities Holdings LLC in Stamford, Connecticut. He expects the euro to trade at $1.30 or lower by the end of 2014.

“There has been a significant downward adjustment in the size of the ECB’s relative balance sheet and that has been a factor that helped the euro stay stronger than people generally expected,” Sinche said in a Dec. 30 interview. “If we look ahead into 2014, we do think the interest-rate advantage is maintained in favor of the dollar and maybe even widen a bit more. The balance-sheet effect will fade as a support.”

Bond yields are moving further in favor of the greenback, with the extra payout that investors get for holding Treasury 10-year notes instead of similar securities issued by Germany, Europe’s largest economy, climbing to 110 basis points at the end of last year, the most since July 2006. The spread has averaged 21 basis points since the start of 2007, and was 90 basis points in favor of the German debt at the end of 2008.

Draghi’s Pledge

Since Draghi said on July 26, 2012, that the ECB was “ready to do whatever it takes” to preserve the euro, the currency has climbed 12 percent versus the dollar, having slipped 7.2 percent in the six months through July 25, 2012.

The ECB’s latest interest-rate reduction on Nov. 7 was predicted by just three of 70 economists surveyed by Bloomberg and came a week after a report showed consumer-price gains in the currency bloc slowed to 0.7 percent that month, the least since November 2009.

Inflation accelerated the following month to an annual 0.9 percent, compared with the ECB’s 2 percent target. During the December meeting, officials briefly debated pushing the deposit rate -- the amount they pay lenders for parking cash at the central bank overnight -- to less than zero, Draghi said at a press conference afterward.

German Pessimism

While the euro is little changed from where it was when Draghi took over the ECB from Jean-Claude Trichet in November 2011, the region’s economy contracted for six consecutive quarters starting at the end of that year.

It only returned to growth this year, expanding 0.3 percent and 0.1 percent in the June and September quarters. It will grow 1 percent this year, compared with 2.6 percent for the U.S., according to Bloomberg surveys of economists.

That’s fueling pessimism toward the currency, with a Commerzbank AG survey of German companies showing that 70 percent of respondents expected it to weaken versus the dollar over 12 months, the biggest proportion in six months.

Money managers increased net-short euro positions by 3,765 contracts to 27,462 in the week ended Dec. 24, the most since the five days through Sept. 3, according to the Washington-based Commodity Futures Trading Commission.

That was biggest increase since the period ended Nov. 5.

“U.S. growth will be better than that in the euro zone and the dollar can win back some ground,” Jane Foley, a senior currency strategist at Rabobank International in London, who predicted in June that the euro would stay little changed in the second half, said on Dec. 19. Foley sees the euro slipping to $1.28 by the end of the year, “which is the most bullish on the dollar I’ve been in years,” she said.

--With assistance from Kristine Aquino in Singapore. Editors: Robert Burgess, Kenneth Pringle