USD has failed to sell off during the bounce in global equity markets. In fact, it seems neither rising nor falling stock prices can stop USD’s march higher and the currency shows no correlation – either positive or negative - with broad measures of risk aversion. That rallies in US stocks should be associated with USD strength is not difficult to rationalise and would be consistent with the long run relationship between USD and measures of broad risk aversion. USD typically rallies as market risk appetite rises.
High frequency data on investment flows to some degree rationalise why sharp falls in stock prices are now also associated with USD strength. Equity market weakness is currently strongly associated with liquidation of overseas asset positions on the part of US investors and repatriation flows into USD. US retail investors’ flows into overseas mutual funds have turned sharply negative in recent weeks. Having invested a net USD240bn in overseas equity funds in between 2004 and August 2008, the first four weeks of September saw net overseas mutual fund redemptions of USD22bn.
US investors’ appetite for overseas mutual funds in recent years has not been matched by demand for domestic funds. Over the last four years, US retail investors have been net sellers of US equities through mutual fund investments. Against this background, it is hardly surprising that it is overseas equity holdings are first to get liquidated during periods of turbulence. Moreover the scope for further selling of overseas stock holdings remains huge.
US investors’ switch into overseas funds over the last 3-4 years appears to be part of a broader picture whereby private sector investors globally have accumulated a large overweight position in non-USD equity investments. The counterpart to this is a similarly large accumulation of USD assets (bonds) on the part of public sector investors (central banks’ reserve holdings). EUR has been a prime beneficiary of this private sector investment flow. Since mid-2005, the Eurozone has seen exceptionally large portfolio inflows, particularly into stocks. Over the last three years, these equity inflows amount to EUR720bn or just short of USD1trn.
The emergence of this investment imbalance has left EUR vulnerable on two counts. When stocks rally, foreign investors scramble to accumulate US stocks, driving EUR/USD lower. When stocks sell off, US investors are heavy sellers of overseas equities, again pushing USD higher and EUR/USD lower. As we enter Q4, a strong bias is maintained toward further USD strength and the risk to 1.38 end-year target for EUR/USD is to the downside if recent equity volatility continues.
0 responses so far ↓
There are no comments yet...Kick things off by filling out the form below.
You must log in to post a comment.