Two weeks ago we were the first to explain that the mysterious Euro levitation observed, as newsflow out of Europe had just turned very ugly, was due solely to another iteration of a very disturbing phenomenon: EUR repatriation, as domestic banks were forced to shore up capital ahead of what they perceived as major liquidity needs such as bond auctions, and the other usual fare - insolvent banks, deposit outflow replacement, etc. As a reminder, the last time such aggressive repatriation was observed was back in October, just before the Fed was forced to ease the terms of its FX swaps, the ECB was forced to announced the LTROs and China was forced to announce an interest rate hike - in other words, the central planner were in bailout mode. Today, the first to address directly our "explanation" is Citi and specifically Stephen Englander, who notes the repatriation is likely a key driver to such inexplicable moves in the EURUSD. Of course, since Englander understands all too well the true implication of such a move (very, very negative as it means liquidity is once again becoming non-existent), he tries to mitigate it: "we find that in the recent past the repatriation theory has some support but that foreign portfolio flows are probably the dominant EUR driver": alas, that is what he said last time too. And it ended up being the other way around, in the process almost resulting in Europe's getting destroyed. Hopefully this time it is different.
EUR support from repatriation
Next to Judge Crater’s disappearance, the euro’s robustness is one of the great mysteries of modern times. There is considerable speculation that the EUR is being supported by euro zone financial firms cutting balance sheets and repatriating assets back to the euro zone. We find some evidence to support this view, although it does not seem to be the full story.
Figures 1 and 2 present portfolio purchases of debt asset by euro zone residents and foreigners. The balance of payments convention is that an inflow (ie net buying of EUR) is a positive. In Figure 1 a positive value mean that EUR residents are net sellers of foreign assets (and buyers of EUR) and in Figure 2 a positive value means that foreigners are net buyers of EUR debt.
Figure 1 shows that euro zone residents were net sellers of foreign assets through most of H2 2011, after having been buyers most of H1. So the view that EUR weakness may have been mitigated in late 2011 by repatriation has been some support from these data.
Figure 1. EURUSD and EUR Net Buying of Foreign Assets
Figure 2. EURUSD and Foreign Buying of EUR Debt
However, that is not the full story. Figure 2 shows that there has been a rough correlation between the EUR and foreign buying of euro zone debt, and the magnitudes are larger. The EUR’s Q4 weakness has a counterpart in foreign selling of EUR debt assets. We see a similar run-up in foreign buying in the H1 2011 that corresponds to the EUR strength over that period. So it looks as if the conventional correlation exists on the liability side. Moreover, broadly speaking, it looks as if the EUR correspondence with foreign buying and selling is stronger than the correspondence with EUR resident buying and selling. On balance these portfolio flows provided some net support for the EUR in September and October, but were very negative late in the year.
We do not yet know what has happened in March and April. Overall we find that in the recent past the repatriation theory has some support but that foreign portfolio flows are probably the dominant EUR driver.