28, 2013 7:02 pm
Markets: Back in the zone
Can flows into the euro last?
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©Chris Batson/FTTraders on US roadshows trying to sell bank bonds from crisis-hit eurozone countries know about difficult pitches. “A year ago, it was very much about ‘what is happening to Europe?’ and ‘how likely is the euro to survive?’ ” recalls Paolo Basso, senior banker at Morgan Stanley.
Promoting a $3.5bn bond issue for Italy’s Intesa Sanpaolo bank this month was a different story. “There was not one question on whether the euro was going to survive ... We did not expect such an overwhelming response,” Mr Basso recalls. In the end, Intesa took more than 400 orders from the US, Europe and Asia.
Intesa’s successful bond offer highlighted the wave of money that has returned to the eurozone in the past few months, especially into the economically-stressed countries on its periphery: Italy, Spain, Ireland, Portugal and even Greece.
Since Mario Draghi, president of the European Central Bank, unveiled in September plans for the eurozone’s monetary guardian to backstop government debt markets, the periphery has seen €93bn of net private inflows – equivalent to about 9 per cent of economic output – in the form of loans and investments, according to calculations by ING, the Dutch bank.
As economic stability has returned, the trade-weighted euro has risen to its highest level since late 2011. Its rise reflects an increasing belief that the danger of a eurozone break-up has passed and that assets in the region offer attractive yields when global rates are at historic lows. It is not just eurozone banks that have noted the mood swing: corporate bond issuance has returned to levels last seen before the region’s crisis erupted in late 2009. Policy makers have started to believe that the eurozone is on a self-sustaining recovery path. This month, Mr Draghi talked of “positive contagion, when things go well”.
But a lasting turnround in sentiment will take more than a few successful bond offers. The recent inflow into the eurozone periphery is still dwarfed by earlier, far larger net outflows of private investors’ funds, which exceeded €400bn in the first eight months of 2012 and were €300bn in the previous year.
Still, some money managers see the turnround as tactical and opportunistic rather than a vote of confidence in Europe’s 14-year-old monetary union.
“I’m not jumping up and down saying ‘now is the time to buy Europe’,” says Robert Brown, chairman of the global investment committee at Towers Watson consultancy, which advises sovereign wealth funds and other investors. “The risk of catastrophe has come down and there are potentially some opportunities but I’m saying that in a rather guarded way.”
A first step in defending the euro came just weeks after Mr Draghi took over as its president in November 2011. The ECB flooded the banking system with more than €1tn in cheap three-year loans or “longer term refinancing operations”. With many eurozone banks having been shut out of capital markets and facing soaring refinancing needs, the ECB’s action averted an immediate catastrophe. In the first three months of 2012, eurozone banks secured vital funding by issuing more than €50bn in debt.
But the ECB’s decisive move came in September. With Spanish and Italian borrowing costs having soared to dangerous levels, the ECB announced a scheme by which it could buy the bonds of eurozone governments that signed up to externally-approved reform programmes. Mr Draghi’s proposed “outright monetary transactions” scheme reduced dramatically the risk of countries defaulting and exiting the euro.
Some view the ECB’s actions, while essential, as palliative. “The OMTs are still seen as the blanket that is suffocating the flames of the eurozone crisis. People are happy to buy into eurozone periphery debt modestly – not massively – on the assumption that the ECB is behind the market,” says Andrew Milligan, head of global strategy at Standard Life Investments.
Eurozone politicians have yet to put in place plans for strengthening the region’s bank system and a new crisis in public finances could quickly emerge: heavily indebted Cyprus, one of the eurozone’s smallest economies, is a possible flashpoint.
“It is still an open question whether the politicians will deliver their side of the bargain,” says Mark Cliffe, chief economist at ING. With the ECB’s actions fuelling a rally in eurozone share and bond prices, however, investors had no option but to jump in, Mr Cliffe adds.
“People felt obliged to reduce their underweight position in these markets because they had been performing so well. Many were so massively underweight in the periphery even a modest rebalancing had a substantial effect.”
Another tactical factor has been the unwinding of speculative bets on a eurozone catastrophe. A hedge fund strategy at the height of the crisis was to “short” the euro by selling assets borrowed in the expectation of being able to buy them back at a cheaper price. After Mr Draghi acted, some hedge funds took losses.
However, aggressive investors who bet on a eurozone recovery have booked gains. Dromeus Capital, a hedge fund set up to invest in distressed Greek assets, netted gains of more than 40 per cent in the first three months. Third Point, another, doubled its money on a €500m bet on Greek government bonds. Franklin Templeton, the asset manager, last year increased its holdings of Irish bonds to at least €8.4bn, which almost certainly spurred a sharp price rally based on the country’s recovery prospects.
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At the same time, signs have emerged that the turnround in sentiment is solidifying. Data from the US Commodity Futures Trading Commission, used to track hedge funds’ extensive foreign exchange dealings, show a build up in net “long” euro positions to the highest level since mid 2011 – although a large number of “short” positions remain.
In government bond markets, Spain last week received total orders of almost €23bn for a €7bn 10-year bond. Some 60 per cent of the issue went to non-Spanish buyers.
“I think the ‘easy’ inflows – the covering of short positions – have happened in Spain. Now there is a little more conviction – and it’s gradually improving,” says Laurent Fransolet, head of fixed-income research at Barclays.
Bond issuance by eurozone banks and companies has risen, taking advantage of investors’ appetites, although, like governments in the periphery, they have paid higher interest rates than in northern Europe. For US investors, who had not followed each twist and turn of the crisis, Mr Draghi’s intervention was the turning point, says Ryan O’Grady, a JPMorgan banker. “They went from a position of being disproportionately detached to disproportionately engaged, which had the effect of reinforcing the rally.” Erik Schotkamp, director of capital and funding management at Spain’s BBVA bank, adds: “American investors were faster [than others] to pick up on the potential of Draghi’s speech and of OMTs.”
With financing conditions recovering, eurozone banks – including in the periphery – will this week repay early €137bn of the three-year funds borrowed from the ECB.
The turnround has become noticeable in flows into eurozone equity and bond markets. Eurozone equities saw outflows in almost every month between mid-2011 and August 2012, according to data compiled for the Financial Times by EPFR, the US-based research company. They were, however, positive in three out of the past four months of the year. “Retail investors have really pulled out of eurozone equities on a big scale since mid-2007, redeeming over $160bn from the European equity funds we track,” says Cameron Brandt, EPFR head of research. “But a lot of the recent flows back in have been from institutional investors, who you’d expect are making that decision with their eyes open.”
The ECB’s actions have led to “a completely different look for the region, which could restore its economic engine”, says Jim Paulsen at Wells Capital Management. “It may be that we are going from 10ft under to 5ft. That doesn’t matter. For investors, it’s momentum that matters.”
Yet recent inflows into eurozone equity funds are still modest even by crisis-standards, and EPFR’s data show inflows into emerging market equity funds have been far stronger lately than flows into European equity funds. Other markets also suggest caution before calling a lasting turnround in investors’ attitudes.
US money market funds, which provide short-term financing, were quick to withdraw from the eurozone when the crisis escalated, dealing a severe blow to banks with project and trading financing operations requiring dollars. Even by the end of November, their allocations to eurozone banks were still 60 per cent below the 2011 peak. “There is a tentative increase,” says Robert Grossman, head of macro credit research at Fitch, the rating agency. “But money market funds are conservative investors and among the first to withdraw and to maintain that caution.”
In foreign exchange markets, an analysis by Deutsche Bank showed a slight bias towards holding euros in January, but Citigroup, another top currency trading bank, reports its clients are neutral. Analysts feel the euro’s appreciation has ended its run and investors are looking for other trades. “Most clients seem to be in a holding pattern, waiting for the next big move,” says Valentin Marinov, a Citi strategist.
Even eurozone bankers who have successfully raised money recently and are keen to talk up deals, know this year’s improved mood could prove fragile. Unexpected political or economic developments could produce fresh tension and, in spite of improvements, stresses remain.
Mr Schotkamp says: “Previously it wasn’t even a question of price. It was just ‘no go’. Now we have access to the market but it remains expensive. The question is whether this is the ‘new normal’.”
Additional reporting by Alice Ross, Michael Stothard and Robin Wigglesworth
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Copyright The Financial Times Limited 2013
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