EUR still has the hedging/under allocation 'tinder' – Deutsche Bank

Alan Ruskin, Macro Strategist at Deutsche Bank, notes that from EUR balance of payments data and Japanese Life insurance numbers, the modest adjustments in asset allocation and hedge ratios over the last 6 months suggest there is still plenty of potential for EUR buying from participants with longerterm investment time horizons. The 'tinder' is there, it just lacks an immediate spark, he further adds.

Key Quotes

“Back in May, after the compilation of the Q1 2017 Life Insurance hedging data and shortly after the French election, we suggested that, “the perceived reduction in EUR political risk premia is likely to encourage trimming in elevated hedge ratios on EUR assets held by foreign funds, and prove helpful for the EUR, notably on key crosses like the yen”.”

“Six months later, the next set of keenly awaited data is in. As it happens, the Lifers' EUR hedge ratios went down from 75.8% to 70.8%. Meanwhile, the USD hedge ratios were little changed, hovering between 48% and 49%, a fraction below the long-term 52% average, and well below the EUR equivalent number.”

“Another interesting aspect of the data is the actual asset allocation. Here again the adjustments have been small, with the USD share of total assets down from at least a 15 year high of 65.9% in March to 64.4% and the EUR off its 15 year low of 17% in March to 18.5%. As we have noted back in May, the Lifer asset allocation has recently had an uncanny resemblance to the COFER Central bank allocated data, where the last comparable numbers for March 2017 showed Central Bank allocated holdings at 64.6% in USD and 19.25% in Euros, respectively. The Lifer data likely portends some similar (only) small increase in the Central Bank's EUR holdings when we get the Q3 data. Allocation adjustments from these big players are then likely to have been small, despite a fairly sizable EUR strengthening versus the USD.”

“Nonetheless, the Japan data fits with the EUR balance of payments data through September, which suggests the post-French election adjustments in both asset allocation, and hedging, have been directionally as one might expect, but of a smaller magnitude, and less EUR positive than seemed likely.”

“As we put all this data together, what we see is that despite the EUR’s significant recovery off its lows, this is still a story of unrequited EUR potential. Potential for further EUR gains, if and when:

i) EUR fixed income becomes more attractive, which probably awaits at least a ECB pullback from negative s/t rates; and,

ii) the potential for a further lowering of foreign hedge ratios on EUR assets, if the EUR can start to push into a new zone that promises more gains - that in turn tend to become self fulfilling. That likely requires EUR/JPY pushing through Y 135 on EUR/JPY and 1.21 on EUR/USD.”

“With the ECB largely out of the picture in H1 2018, there are few obvious sources to propel the EUR higher until H2 2018. This is then still a story of EUR under-allocation, and foreigner over-hedging on EUR assets. The 'tinder' is there for EUR gains but before the ECB gets active again, it lacks an obvious spark.”