A 300 basis point rate hike by the European Central Bank since July has halted a multi-year exodus from regional fixed income funds. According to data compiled by Deutsche Bank AG, net capital flight, which reached 818 billion euros at the end of 2021 – the highest in at least 20 years – has now halted.
Higher bond yields, as well as relief that Russia’s war against Ukraine has not led to a deeper energy crisis, also remove a fundamental hurdle for the single currency as capital moves from high-yield markets like the US to euro-denominated assets. .
“Major flows are getting significantly more positive for the euro this year. Money managers tell us they are seeing waves of investment in European fixed income for the first time in a long time,” said George Saravelos, head of global currency research at Deutsche Bank.
The ECB has kept interest rates negative for years to cut borrowing costs and has raised trillions of bonds, first to fight stagnant growth and then the COVID outbreak.
In response, investors reduced the share of euro-denominated bonds in European investment funds by 14 percentage points. between 2014 and 2021, which Deutsche Bank strategists said ultimately led to a €500 billion decline.
Now with yields at their highest level in years and attitudes towards fixed income much more positive as the ECB catches up with the Federal Reserve’s rate hike and net flows are poised to turn positive, Deutsche Bank data show. Money markets are pricing further ECB increases of nearly 125 basis points, compared with an additional 75 basis points in the US.
“There will be a narrowing gap between Fed and ECB rates,” said Paul Jackson, global head of asset allocation research at Invesco Asset Management Ltd. “That’s why the euro is likely to continue to strengthen during this year.”
The reversal in flows is a key factor supporting Deutsche Bank’s long-term bullish outlook, even as the dollar rose this month. On Friday, the euro traded around $1.07, down from a recent high of $1.10 on Feb. 2.
According to Keith Jakes, chief global currency strategist at Societe Generale SA, as lower energy prices help rebuild the EU current account surplus, it is possible that the euro could eventually return to its pre-QE (quantitative easing) trading range. The single currency reached a ten-year high of $1.40 in 2014.
“The ECB has pushed European investors out of European bonds and now is actually allowing them to come back,” he said.
