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Deutsche.02.26.14 .pdf


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Deutsche Bank
Markets Research
Global

Foreign Exchange
FX Spot

Date
26 February 2014

FX Daily
Get real on euro
The single best explanation for the euro’s resilience is real yields. Eurozone real
yields have moved steadily higher since the trough in summer 2012 and
exceeded US ones last autumn. Breaking down the move into its component
parts, the overwhelming contribution has come from the fall in Eurozone CPI
from a peak of 3% in late 2011 to 0.7% at the latest print. Rates have remained
static through the period as the ECB has struggled against the zero bound.
It’s hard to see, however, how real yields can be any more supportive of the
euro. First, any further decline in inflation would almost certainly result in the
aggressive reaction from the ECB that has so far been frustratingly absent. The
taboo over negative nominal rates has been overcome and the central bank has
gone out of its way to suggest that political obstacles to QE can be surmounted.
This is not to say that the ECB will be successful in driving real yields
significantly lower, but given the macro risks that a Japan-style scenario entails
for debt sustainability and peripheral adjustment, the disinflation/ interest rate
dynamic cannot remain a one-way street. Second, we may anyway have
reached the trough in Eurozone inflation. Our economist thinks so, forecasting
headline HICP to climb gradually to 1.1% by the end of the year. On Friday,
Eurozone flash HICP is released. A stronger than expected (0.7%) outturn may
see EUR/USD squeeze higher as chances of easing at the March meeting are
discounted, but in the long-run this will not be bullish for the euro.
Flows have also been exceptionally supportive. But again, it is improbable they
can help more. Rebounding domestic demand should prove an obstacle to
further current account improvement (the December data confirmed recent
stabilization). Huge foreign portfolio inflows are a puzzle, but less remarked upon
have been supportive M&A flows through 2012 and 2013. Net inflows have
turned flat YTD, while US ones have skyrocketed. Unlike the broader balance of
payments, EUR/USD has closely tracked this series over time. Notwithstanding
our bullish view on the US economy and Fed after the weak weather, therefore,
the risk /reward to be short EUR/USD is better than ever.
EUR/USD has been driven by real yields

Rise in euro real yields almost all driven by disinflation

Germany - US 2 year yields - minus headline CPI
4.5

1.7

EUR/USD, rhs

6

Eurozone 2 year interest rates
Eurozone CPI, yoy, inverted
EUR real yields

1.6

3.5

4

2.5

1.5

2
1.5

1.4

0

0.5
1.3

-2

1.2

-4

1.1

-6
Jan-00

-0.5
-1.5

-2.5
Jan-06

Jan-08

Jan-10

Source: Deutsche Bank, Bloomberg Finance LP,

Jan-12

Jan-14

Jan-02

Jan-04

Jan-06

Jan-08

Jan-10

Jan-12

Jan-14

Source: Deutsche Bank, Bloomberg Finance LP

________________________________________________________________________________________________________________
Deutsche Bank Securities Inc.

26 February 2014
FX Daily: Get real on euro

Portfolio inflows and the current account have driven

But net M&A flows are already pointing euro lower

Eurozone basic balance higher
3 month net M&A flows, 2wk ma
6 month changes, EUR/USD

Portfolio investment, % GDP
5%
4%

Direct Investment, % GDP
Current account balance, % GDP

40%

150

Basic Balance

30%
100

3%
2%

20%

50

10%

1%

0%

0

0%

-10%

-1%

-50
-20%

-2%

-100

-30%

-3%
-4%
Jan-03 May-04 Sep-05

Jan-07 May-08 Sep-09

Source: Deutsche Bank, Bloomberg Finance LP

Page 2

Jan-11 May-12 Sep-13

-150
Jan-00

-40%
Jan-02

Jan-04

Jan-06

Jan-08

Jan-10

Jan-12

Jan-14

Source: Deutsche Bank, Bloomberg Finance LP

Deutsche Bank Securities Inc.


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