Revisiting The "Biggest Ever Headfake" Out Of Europe

About a month ago we suggested that the EUR weakness was perhaps a major headfake as liquidity runs and repatriation flows would sustain a stronger-than-expected EUR (especially relative to the USD). Well, today Deutsche Bank's Macro strategist points out that French balance of payments data was hugely revealing about this potential source of strength. While we note that EURUSD remains hugely disconnected from its empirical relationship with sovereign spreads (GDP-weighted), swap-spreads, financial-to-corporate risk differentials, and equity prices - it seems the the typically negative investment abroad (outflows) has now seen 4 months of inflows (too long a period to be simply noise) and with considerable size also. While DB's analysis offers little guidance on when this period of repatriation will be over - we suspect there is more support to come than many expect - even as everything points to a weaker EUR. One broad conclusion is that the EUR is probably the worst instrument to express negative EUR area views, with both periphery bonds and equities purer gauges of stress.


Monthly data shows that France is the biggest source of portfolio repatriation flows with EMU by a considerable margin.

Italy, Spain and Germany have seen net portfolio outflows running at 3m averages of EUR 3bn, 4bn and 4bn respectively, very modest when compared with France

Deutsche Bank's Alan Ruskin summarizes the flows as follows:


  • Although it is not clear how much portfolio liquidation results in a foreign exchange transaction, particularly if assets are funded in the same currency, the latest data would then fit again with the FX Daily from 9 November that highlighted some of the differences between the US and EUR balance payments inclusive of the C/A+FDI and related bond flows as the best explanation for EUR resilience. However, the latest numbers do challenge the thesis that as problems reach the core countries and the EUR area acts as less of a self contained area (with EUR periphery outflows no longer mostly ending up in the core, but all areas seeing net outflows) that the EUR will automatically come under more pressure.
  • The repatriation arguments would tend to suggest that outflows from the periphery and the core will not be enough to sink the EUR until such time as we also see repatriation flows dry up. When will repatriation dry-up involves assessing what the desired stock adjustment of assets might be, in a world of persistent EUR turmoil, and is beyond the scope of this piece.
  • One broad conclusion is that the EUR is probably the worst instrument to express negative EUR area views, with both periphery bonds and equities purer gauges of stress.
  • The portfolio data would fit with the DB Select data that suggests that leveraged funds have their EUR fund on, but are getting no joy, because of both the broadly flat underlying EUR area basic balance position, in combination with net portfolio inflows, partly related to the repatriation story.
  • In general it would be expected that repatriation flows, to support year-end window dressing should offer the EUR a degree of support in the coming month. Even from a medium-term standpoint, this would play to selling realized volatility, since the EUR crisis will provide plenty of constraint to EURUSD’s upside, while the above story suggests there is some less visible protection on the admittedly much more vulnerable downside.