Funding the euro

Has the euro become the new carry currency of choice? That’s the suggestion being thrown around on the back of the performance seen so far this year, together with the injection of 3-yr funds last month and the talk of anything up to EUR 1trln or more at the next 3-yr tender next month. We’ll have to wait a month or two for official data to fill in some of the gaps, so it’s really only the market action that we have to go on at present.

When the ECB first started injecting long-term funds in 2009, it was the internal carry trade that was more prevalent - banks using money from the ECB’s longer-term tenders to invest in the euro-denominated bond market. That is where around half of the cash went. This time around, bond auctions have gone well but the ECB’s own analysis (January Monthly Bulletin) showed a strong correlation between banks’ funding needs and the level of participation in the 3-yr auction. This suggests that funding carry trades is not the primary motivation for taking cash. Indeed, banks do and should have more pressing matters on their minds, such as meeting new capital requirements by mid-year.

There’s certainly evidence that the euro is trading as less of a risk asset so far this year. The breakout on EUR/AUD (3% lower) illustrates this well, as does the breakdown in the correlation between EUR/USD and equities (S&P). But even beyond the euro moves, the dollar has been playing its part, USD having held its ground vs. some of the less high-beta currencies such as sterling, at least to a greater degree than past correlations vs. equities suggest should be the case. In sum, whilst it’s likely that there is some downward pressure on the single currency from carry, it is not likely to prove substantive not least because, as 2008 showed all too clearly, the rush for the exits on a turn can be highly costly.