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Euro gains favor for carry trades amid rate cut speculations, forex landscape analysis

euro and forex landscape analysis

Looming European interest-rate cuts have positioned the euro as a prime candidate for funding carry trades, intensifying pressure on the common currency. Financial giants like Goldman Sachs and JPMorgan Chase are actively advocating for the strategy of borrowing the euro to invest in riskier, higher-yielding currencies.

Simultaneously, money managers at Allspring Global Investments and Ninety One Asset Management are showing a preference for the trade against emerging-market currencies. In a more diversified approach, Allspring is also wagering on the euro's decline against the US dollar.

This conviction gained significant momentum when European Central Bank President Christine Lagarde hinted at the possibility of earlier rate cuts. Lagarde's indication contributed to the euro recording the worst weekly performance among its Group-of-10 peers. Projections now suggest that the key rate in the euro area may plummet as low as 2.5% by the end of 2024, sharply contrasting with the anticipated 4% for the US as we read in Bloomberg.

The euro's newfound popularity as a funding currency may trigger far-reaching consequences. Traditionally, sub-zero interest rates at the Bank of Japan made borrowing yen more cost-effective, resulting in a depreciation of the currency.

However, as traders grow more confident about impending rate hikes, they are actively seeking alternatives, with the euro emerging as an attractive option despite facing several challenges, including Germany's sluggish economy and weak private-sector activity.

Kamakshya Trivedi, Head of Global Currency, Rates, and Emerging-Market Strategy at Goldman Sachs, acknowledges that "The euro faces a number of stiff headwinds," but underscores its persistent attractiveness as a funding option.

Despite Lagarde's insistence on an unchanged stance on rate cuts, her acknowledgment of stumbling economic growth and disinflation has led traders to almost fully price in a quarter-point cut in April.

Lauren Van Biljon, Portfolio Manager at Allspring Global Investments, observes that the growth in Europe appears more precarious than in other G10 nations, potentially creating room for the European Central Bank (ECB) to cut rates in the second quarter ahead of the US and the UK.

Responding to this outlook, Allspring has adjusted positions, adding underweight euro positions against the US dollar in global bond portfolios, leveraging the euro's low volatility for funding positions in higher-yielding emerging-market currencies.

Goldman Sachs is positioning for a weaker euro against the Indian rupee, anticipating a 3% fall to 88 rupees. For a riskier trade, the recommendation is to sell the euro for the Mexican peso and the Brazilian real.

On the contrary, JPMorgan sees hindrances to a recovery for the euro due to US economic strength, geopolitical risks, and euro-area weakness, resulting in a 1.6% decline in the currency since the start of the year.

Meera Chandan, Co-head of Global FX Strategy at JPMorgan, suggests that the euro is "best used as a funder rather than a recovery candidate as central banks turn dovish." Although the trade may see greater success when rate cuts are officially underway, it has already proven profitable relative to the dollar.

Buying the high-yielding Argentine peso with borrowed euros has returned 8% this month, surpassing the 6% return if the dollar was used instead. A similar trend is seen against the yen, where the trade returned 11%.

Valentin Marinov, Head of G10 Currency Research at Credit Agricole CIB, notes increasing client discussions about shorting the euro against the Mexican peso, the real, and the rupee, especially as the BOJ and ECB policy cycles are expected to diverge from the second quarter onward.

Ugo Lancioni from Neuberger Berman and Michael Sager from CIBC Asset Management favor alternatives to the euro, with both expressing a preference for the Swiss franc. Sager additionally suggests considering the Chinese renminbi. However, as the rate gap between Japan and Europe narrows, a shift from the yen to the euro appears likely.

Iain Cunningham, Head of Multi-Asset Growth at Ninety One Asset Management, emphasizes the potential for a change in the euro's favor over the next 12-18 months, betting on the euro's fall against the yen.

He employs borrowed euros to invest in the Turkish lira, South African rand, and Chilean peso, citing the anticipated relative easing in Europe and tightening in Japan.



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