EUR at parity with the USD? The more likely scenario for us – EUR to go sub-parity and head towards an initial level of USD0.90. There are two oft cited reasons for EUR weakness:
- The European Central Bank’s €1.1trillion asset purchase program that was launched on March 9th 2015 and targeted to last till September 2016. This money printing exercise aims to (i) avert deflation; and (ii) lower long-term interest rates (by buying qualifying government bonds) to encourage spending by both consumers and businesses and enable stable economic growth.
- Diverging monetary policy stances by the US Federal Reserve and the ECB. Regardless of whether the US Federal Reserve will raise the Fed Funds rate this year (our stance is the US Fed won’t), the fact is that negative yields in Eurozone are pitted against expectations of a rate hike in the US.
Indisputably, these are the 2 key reasons for continued EUR weakness. There is however, another factor at play. The Wisdomtree Europe Hedged Equity Fund invests in European stocks and hedges EUR currency risks. According to the Wall Street Journal (March 8th, 2015) investor demand for this fund is sky-rocketing. Morningstar reports that this fund saw inflows of US$6.1billion January through March 4th this year. This speaks to the need by foreign investors to hedge EUR-denominated investments. Given the current ECB imposed negative interest rate regime, foreign investors are positively motivated to do away with the currency risk from their European investments. High FX hedge ratios neutralizes the EUR currency’s ability to benefit from equity inflows and limits positive support for the EUR.
The ECB’s push to arrest deflation and improve trade competitiveness coupled with continued FX hedging by foreign investors point to a cheaper EUR. Any potential rebounds will be fleeting and capped by FX hedging activities.