The Euro, Capital Flows and Speculative Trades

Quantitative Easing is generally seen as being negative for the currency in question, and the evidence would seem to support this, albeit not in all situations (sterling, for example). The ECB certainly believes that to be the case, the rationale being that lower bond yields in the EA will prompt investors to seek higher returns abroad, so resulting in portfolio outflows and hence selling of the single currency. The euro has certainly depreciated, both in broad trade weighted terms and against the other majors, and in May was 9.5% below its trade weighted value a year earlier, incorporating a 19% fall against the US dollar and a 12% decline against sterling.

Yet we also know that short-term currency moves can be strongly influenced by speculative positioning, with traders shorting a currency in the belief that QE should  be negative for its FX value, which then sets up something of a self-fulfilling prophecy for a time , as any initial weakness then prompts further selling given that momentum trading appears to be the predominant style at the moment. Data in the Commitment of Traders weekly report from the CFTC ( incorporating  FX futures ) provides a useful guide to speculative  positioning, and from that it is clear that the market started to build a very large short position in the euro/dollar last autumn and one which increased further  following the QE announcement in January.  The position peaked at a  record high in late March, at the equivalent of €28bn, and has unwound sharply since  to currently stand at €11bn, the lowest in almost a year. So the  initial fall in the euro and recent recovery would seem to owe something at least to speculative trades.  It is also worth noting that the unwind of the euro shorts coincided with a strong increase in short yen positions and a fall  in the yen against the US dollar.

What about more fundamental drivers of the euro, as captured in the Balance of Payments? The first point to note is that the EA runs a current account surplus, largely reflecting a positive merchandise trade balance, and one which is growing; the surplus rose to €212bn in 2014 and amounted to €245bn in the twelve months to April 2015, the latest data available. That surplus would therefore generally put upward pressure on the currency unless offset by capital outflows, which brings us back to the ECB’s hope that QE will stimulate such flows.

There has certainly been a significant change in terms of net  portfolio flows. with a net outflow of €160bn in the twelve months to April 2015, against a net inflow of €50bn in the year to April 2014. Moreover, outflows do indeed tend to be in terms of bond purchase, with  EA buying of foreign debt instruments  amounting to €119bn in the first four months of this year alone, which alongside some modest selling of other assets resulted in a rise in total portfolio outflows of €109bn.  Yet QE has also been associated with a significant rally in European stock markets, and  the same period has seen portfolio inflows of €76bn,  including €96bn in equities. So since the announcement of QE the outflow from debt investors has been offset to a fair degree by the inflow from equity investors albeit still leaving a net  portfolio outflow of  €33bn in the four months to end-April.

Direct investment flows also matter, however,  and here again the first four months of 2015 have seen strong inflows, amounting to €86bn, offsetting outflows of  €35bn to give a net inflow figure of  €51bn.  So net capital flows in total (portfolio plus direct) are small  to date  this year and actually a net positive (€19n) which added to a cumulative current account surplus of €69bn implies a inflow of €88bn. The errors and omissions on the BOP data can be very large and there are other financial flows associated with the banking sector but on the basis of the available figures  it is difficult to build a case that QE has led to the flows anticipated by the ECB or on a scale which might have led to a significant euro weakness. It is early days yet, of course, and higher US rates later in the year may trigger greater bond outflows, or indeed an outcome from the Greece negotiations which is seen as negative for the single currency.