Euro zone recovery stronger than most expect
EUR strength is here to stay!
Vasileios Gkionakis, Global Head of FX Strategy, UniCredit Group
May 2014
The themes that will dominate markets in the rest of 2014…
 More risk normalization: our 2013 story of risk normalization played out very well; we
expect it to continue for most part of 2014
 Fed tapering: the Federal Reserve will continue with its gradual withdrawal of asset
purchases; we expect this will conclude in 3Q14
 Eurozone: the recovery in the Euro zone will be stronger than most expect on the back
of domestic demand improvement
 China: the gradual structural slowdown will continue
 BoE: we expect the Bank of England to start a gradual hiking cycle in 4Q14, earlier
than consensus
 EM: as interest rates rise differentiation among EM will be a key theme this year
2
…and implications for the FX market in 2014
 EUR: our out-of-consensus call for EUR-USD is at 1.45 by year-end. We expect the
common currency to trade firm on the back of a stronger European recovery, an
increasing C/A surplus, more demand for EUR-denominated reserves and inflows to
Euro zone risk assets
 USD: the US recovery and rising interest rates should support the US dollar against a
number of currencies including JPY, CHF and SEK, on account of divergent monetary
policies
 JPY: the continuation of risk normalization alongside potentially further monetary policy
easing by the BoJ should put downside pressure on the yen
 CHF: as risk premia across the periphery of Europe compress further, the SFr should
finally start to weaken as Swiss international portfolio investment returns to long term
averages
 CEEMEA: PLN should continue to outperform due to spill over from a strong German
growth and domestic demand picking up; the HUF is likely to be the underperformer
amidst measures that erode the carry further; TRY should benefit from high carry and
improvements in the external account
3
2014 FX Themes: EUR to appreciate further; USD to strengthen
against a number of currencies; Yen and SFr to weaken
 Stronger growth in the US (we forecast 2.8% yoy for 2014)
 Stronger growth in the Euro zone (we forecast 1.5% yoy for 2014)
 Stronger growth in the UK (we forecast 3.2% yoy)
 Yields in major developed countries will move higher (we forecast US 10Y at
3.5%; Bund 10Y at 2.2%; and Gilt 10Y at 3.6% by year-end)
 These movements will impact currency pairs – although several other
idiosyncratic factors will play a crucial role
4
EUR-USD: it is all about growth prospects!
58
56
54
1.50
EZ Composite
PMI, 3M MA
EUR-USD (RS)
-10
1.5%
-5
1.0%
1.45
0
Correlation = 0.83
0.5%
5
0.0%
1.40
52
10
-0.5%
50
1.35
15
-1.0%
20
48
1.30
25
46
30
1.25
44
42
Jun-11 Dec-11 Jun-12 Dec-12 Jun-13 Dec-13
5
35
1.20
40
EA: Change in
Credit Stds for
Bus Loans: Past
3M: Overall
(0+=tightened)
QoQ Euro zone
GDP growth rate
(RS)
-1.5%
-2.0%
-2.5%
-3.0%
Sources Haver, Bloomberg, UniCredit Research.
C/A surpluses should provide additional support to the common
currency
C/A as % of GDP is recording record high surplus….
…and it is not only about the core!
10
4.00
Euro zone
UK
US
3.00
Record high C/A as % of GDP
5
2.00
1.00
0
0.00
-1.00
-5
-2.00
-3.00
-10
-4.00
-5.00
-15
-6.00
Spain
Portugal
Ireland
6
Mar-13
Mar-12
Mar-11
Mar-10
Mar-09
Mar-08
Mar-07
Mar-06
Mar-05
Mar-04
Mar-03
Mar-02
Mar-01
Mar-00
Mar-99
-7.00
Italy
Greece
-20
Mar-00 Mar-02 Mar-04 Mar-06 Mar-08 Mar-10 Mar-12
Source: Markit, UniCredit Research
…and consumer confidence is registering multi-year highs!...
which should drive inflation higher in the near future
0.00
5
-5.00
4
-10.00
3
-15.00
-20.00
2
-25.00
1
-30.00
0
-35.00
EC Consumer Confidence
EZ CPI, yoy, %, lagged by 6M (RS)
-40.00
Jan-05
7
-1
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
Jan-13
Jan-14
Sources: Bloomberg, UniCredit Research.
Reserve managers have significantly increased their holdings in safe
haven FX mostly at the expense of EUR…this is likely to correct as
perception of sovereign risk for Europe normalizes further
26%
180%
2Q10-2Q13 Growth in FX
reserves
25%
160%
140%
EUR as % of allocated reserves, const x rate
164.2%
Average 12Q growth in FX
reserves between 1999 2010
Trend until 2Q10
24%
120%
23%
100%
22%
71.4%
80%
21%
60%
46.6%
43.9%
20%
Evidence of a turn in the latest data
40%
25.5%
20%
19%
14.4%
8.2%
18%
0%
-0.5%
-20%
USD
8
EUR
JPY
CHF
17%
Mar-99
Mar-02
Mar-05
Mar-08
Mar-11
Source: IMF, UniCredit Research
Eurozone equities have underperformed excessively their US
counterparts…with sovereign risk now normalizing European equities are
likely to see significant flows which will support the EUR further
1
180
EuroStoxx 50 (Jan 04 = 100)
S&P500 (Jan 04 = 100)
0.8
Massive underperformance
160
140
120
0.6
0.4
0.2
0
12M rolling
correlation between
SX5E and EURUSD monthly
returns
Average for the
period
100
-0.2
80
-0.4
Jan-14
Jan-13
Jan-12
Jan-11
Jan-10
Jan-09
Jan-08
Jan-07
Jan-06
Jan-14
Jan-13
Jan-12
Jan-11
Jan-10
Jan-09
Jan-08
Jan-07
Jan-06
Jan-05
Jan-04
9
Jan-05
-0.6
60
Source: Bloomberg, UniCredit Research
There is little the ECB can do to prevent EUR appreciation in the
medium term!
 Verbal intervention is rarely successful in the medium term when not backed by
a high probability of actual intervention…something the ECB has not done in the
past!
 The ECB could deliver another symbolic cut to the refi rate and/or announce a
"Funding for Lending" scheme, in order to address the problem of
fragmentation. These two measures could weaken the EUR in the short term but
are unlikely to have a lasting impact
 The only measure that could deliver a serious blow to the currency would be a
full-blown QE (purchases of government bonds). However, this is highly unlikely
in our view, because:
 The central bank cannot engage in QE as a response to currency
appreciation
 Economic recovery is preceding better than most expected
 Inflation has shown signs of having bottomed in March should start
gradually picking up…
 ….in other words, the "bar" for initiating a QE programme is very high
in our view
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The Euro zone recovery is having positive spill over effects to
Central and Eastern Europe
…and more is to come!...given the historical
correlations with the improving Euro zone PMI
Manufacturing PMIs, 3M MA
With the exception of Russia, all trend-PMIs are firmly
above the break-even level of 50…
1
65
Correlations with EZ Manufacturing PMI
0.9
60
0.8
55
0.7
0.6
50
0.5
45
Poland
Hungary
40
35
30
0.4
0.3
Czech
Republic
Turkey
0.2
Russia
0.1
0
Czech
Republic
11
Poland
Russia
Hungary
Turkey
Source: Markit, UniCredit Research
Poland stands to benefit the most
 PLN: the rebound in domestic activity and spill-overs from German growth
should benefit Poland the most in the region and result in PLN
outperformance. We forecast EUR-PLN at 4.05 by year-end
 HUF: the worsening net international investment position, the large foreign
ownership of domestic bonds which is subject to reversal on the back of Fed's
tapering and the increased domestic liquidity that erodes the carry further
should pose some headwinds for the HUF, which we think will underperform
in CEE. We forecast EUR-HUF at 308 by year-end
 TRY: we expect further improvement in Turley's C/A balance to around -4.8%
of GDP this year; this, alongside the high carry should provide cushion to the
Turkish Lira
 RUB: we have pencilled in just 0.5% of annual growth in GDP. Russia will
have problems managing the slowing of domestic demand, high inflation
rates and the potential acceleration of capital outflows
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Croatia: looking for growth drivers
 We forecast a contraction of 1% in GDP yoy for this year; this is largely driven
by declining private demand and cuts in government spending, although the
recovery in the Euro area will have some partial offsetting effects
 Downside risks exist to this scenario given the country's current credit rating
 Fiscal consolidation has made steps in the right direction but more structural
reforms are needed
 Adoption of the EUR is still some years away; the current contraction in the
economy makes meeting the convergence criteria more difficult; at the same
time, Croatia needs to have the currency flexibility to become more
competitive
 The ratings outlook poses a challenge for the short-to-medium term. Only
accelerated efforts toward addressing key structural economic and budgetary
challenges can lead to an upgrade in rating
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