Currency

Goldman, JPMorgan See Euro Challenging Yen as Carry-Trade Funder


(Bloomberg) — Looming European interest-rate cuts have set the euro up as a prime candidate for funding carry trades, adding further pressure on the common currency.

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Goldman Sachs Group Inc. and JPMorgan Chase & Co. are recommending borrowing the euro to buy riskier, higher-yielding currencies. Money managers at Allspring Global Investments and Ninety One Asset Management favor the trade against emerging-market currencies, while Allspring is also betting the euro will fall against the US dollar.

Those convictions got a boost this week as European Central Bank President Christine Lagarde ended up opening the door to earlier cuts, helping the euro notch the worst weekly performance of its Group-of-10 peers. The key rate in the euro area is expected to end 2024 as low as 2.5%, compared with 4% for the US.

The euro’s emergence as a popular funding currency may have far reaching consequences. Over the past two years, sub-zero interest rates at the Bank of Japan meant it cost less to borrow yen, and drove the currency to the lowest in decades. But as traders grow more confident a hike is coming, they’re looking for alternatives.

“The euro faces a number of stiff headwinds,” including Germany’s stuttering economy and weak private-sector activity, said Kamakshya Trivedi head of global currency, rates and emerging-market strategy at Goldman Sachs. “It remains an attractive funding option.”

Despite insisting her stance on rate cuts was unchanged, Lagarde’s acknowledgment on Thursday of stumbling economic growth, cooling wage pressure and continued disinflation was all traders needed almost fully price a quarter-point cut in April.

“Growth in Europe feels more precarious than elsewhere in G-10,” said Lauren Van Biljon portfolio manager at Allspring Global Investments. That “could create space for the ECB to cut in the second quarter, ahead of the US and the UK.”

Allspring added underweight euro positions against the US dollar across global bond portfolios this month. The euro’s low volatility — the one-month implied rate versus the dollar is near a two-year low — makes it one of Van Biljon’s favored ways of funding positions in higher-yielding emerging-market currencies.

Goldman Sachs is betting on a weaker euro versus the Indian rupee, predicting it will fall about 3% to 88 rupees. For a riskier trade, they recommend selling the euro for the Mexican peso and the Brazilian real.

At JPMorgan, strategists say US economic strength, geopolitical risks and euro-area weakness hinder a recovery for the common currency. The currency is down 1.6% since the start of the year.

The euro is “best used as a funder rather than a recovery candidate as central banks turn dovish,” said Meera Chandan co-head of global FX strategy at JPMorgan.

While the trade may be more successful when rate cuts are officially underway, it has already paid out relative to the dollar.

Buying the high-yielding Argentine peso with borrowed euros returned 8% this month, compared to 6% if the dollar was used instead, according to data compiled by Bloomberg. Against the yen, the trade returned 11%.

Diverging in Earnest

Valentin Marinov, head of G-10 currency research at Credit Agricole CIB, said clients have been discussing shorting the euro against the Mexican peso, the real and the rupee.

“These could become more appealing once the BOJ and ECB policy cycles start diverging in earnest from the second quarter,” he said.

Meanwhile, Neuberger Berman’s Ugo Lancioni and CIBC Asset Management’s Michael Sager say there are better options than the euro. Both favor the Swiss franc, while Sager also suggests Chinese renminbi.

But with the rate gap between Japan and Europe narrowing, a change of guard from the yen to the euro looks likely.

“The greatest asymmetry in positioning over the next 12-18 months is between Europe and Japan,” said Iain Cunningham, head of multi-asset growth at Ninety One Asset Management, who is betting the euro will fall against the yen. He’s been using borrowed euros to buy the Turkish lira, South African rand and Chilean peso.

“Relative to what’s priced in, Europe will be compelled to ease and Japan to tighten.”

–With assistance from Naomi Tajitsu.

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