EUR: Safe haven? - Rabobank

A climb down in bond yields after yesterday’s lurch higher has calmed nerves in the market this morning as the yield on 10 year US t-notes pushed back from its highest level since 2014 partly on the back of a report from China that yesterday’s news that officials had recommended slowing or halting US treasuries could have been fake, explains Jane Foley, Senior FX Strategist at Rabobank.  

Key Quotes

“Whether or not there were buyers from China, the strength of demand for 10 yr notes at yesterday’s auction indicated that there is still plenty of interest in the paper.  Indeed, it is our view that this week’s speculation regarding the end of the bull market for bonds is overdone.  That said, even though sentiment has stabilised this morning, yesterday’s activity does provide an interesting backdrop for a discussion about safe havens in the FX market.  In particular the roles the USD and the EUR would likely play if market sentiment soured again in the coming months.” 

“EUR/USD surged yesterday on the report that China may be less interesting in buying US treasuries. In the hours that followed most of the move was reversed as the market digested some of the home truths around this news.  Firstly it is rare for an asset manager, particularly such a large one, to advertise its strategy before it is implemented.  Inevitably this is likely to sour market conditions against it.”

“Also, all real money fund managers are also constantly grappling with the issue that if holdings in one asset are reduced, an alternative must be considered.  China could move down the curve or tweak its holdings of US treasuries but the liquidity that this market offers cannot easily be replicated for an investor of such scale.  Certainly there would be difficulties for China to enter the Bund market in scale given that the ECB is already a domineering presence.  This realisation most likely contributed to the recovery in the USD vs. the EUR yesterday afternoon.  However, the strength of that initial reaction in favour of the EUR adds to signs that the single currency is behaving as a quasi-safe haven.” 

“The world only needs so many safe havens. By definition there must be an exclusivity about the role of a safe haven.  We continue to argue that the CHF and the JPY remain the prime safe haven in the FX market and suggest that there is little need for both the EUR and the USD to offer back up functions simultaneously.  In our view, the USD has never had a comfortable or sincere relationship with safe haven flows.  The fact that treasuries are a safe haven, the huge degree of liquidity in the USD and the credibility in the US legal system offers often lead to support for the USD in spates of market stress.  However, there has rarely been much follow through.  The US runs a large current account deficit and a budget deficit and these factors indicate that the greenback is not a true safe haven currency.” 

“During 2017 the worsening in tensions between N. Korea and the US, threw a positive light on the EUR at a time when the Eurozone’s fundamentals were independently improving. The result was that the EUR appeared to adopt safe haven behaviours last year in times of increased market tension.  It is not the only currency ever to have done this.  During the Eurozone debt crisis, GBP often behaved as a safe haven, due to its ability to offer a diversification trade.  Now that the memory of the debt crisis has faded and strong growth is hiding some of the political strains of EMU, the relative strength of the Eurozone fundamentals is serving to underpin the EUR as a quasi-safe haven.  In contrast to the US, the Eurozone offers a huge current surplus.  This factor has likely being instrumental in guiding last year’s rebalancing from the USD back into the EUR. It also suggests that, all other factors being equal, the EUR should be a better safe haven than the USD.  This morning Germany announced that its 2017 budget surplus was a better than expected 1.2% of GDP.  Such news can only strengthen the EUR’s credibility particularly as a time when the outlook for the US budget is mired in a debate about the impact of the Republican’s tax reform.” 

“On balance, the ghosts of the Eurozone’s debt crisis are too close for the EUR to officially adopt a safe haven status. However, given the current strength of growth and the reduction in perceived political risks in the region we would expect the EUR to continue displaying safe haven behaviours in time of increased market tension this year.  Assuming no significant shocks, we expect EUR/USD to end the year higher in the region of 1.24.”