The persistence of such large amounts of negative-yielding euro zone debt was putting off global investors and potentially detracting from the value of the euro as a result.

Most currencies have been crushed by the dollar this year. Higher US interest rates have widely been blamed for this with the yen’s particular weakness seen to be a sure sign of the interest rate differential effect given that the BoJ has been the only advanced-country central bank to eschew higher policy rates. But there’s an alternative – better – explanation which relates to trade and capital flows, except that this one might offer some hope that the US dollar could soon start to fall.

For us, the biggest development over the past year has not been the sharp rise in policy rates from the Fed and other central banks. Instead, it has been the massive discrepancy in the terms of trade between relatively energy-rich economies like the US, and the poor ones such as the euro zone and Japan. This has led to huge trade discrepancies and, in Mr. Steve Barrow, Head of Standard Bank G10 Strategy’s view, weighed on currencies like the euro and yen, but helped others such as the US dollar and Canadian dollar.

In the euro zone, for instance, the surge in energy prices resulting from Russia- Ukraine conflict has led to an energy deficit of EUR491bn in the January-September period of this year; far in excess of the EUR180bn from the same period of 2021. Given such a ball and chain around its ankle, it is not surprising that the current account has shrunk to a deficit of EUR50bn in the year to September compared to a surplus of EUR336bn in the year to September 2021. It is also not surprising in Mr. Steve Barrow’s view that this dramatic turnaround weighed heavily on the euro. The situation is very similar when it comes to the yen, or the pound for that matter. But what about the future outlook?

Mr. Steve Barrow thinks there’s two things to point out here. The first is the prospect for some modest trade improvement and the second is what’s been happening to capital flows. On the former, the moderation in energy prices, particularly gas prices, and the likely recession in the euro zone economy, which will cut imports, should lead to some improvement in the trade and current accounts. Quite clearly the trade accounts won’t recapture all the ground that they have lost over the previous year, but at least the bleeding should stop. However, it might be capital flows that are of more significance.

“We say this because the surge in global inflation, including in the euro zone, has rid the region of all the negative-yielding debt that had been built up over many years”, said Mr. Steve Barrow.

On a global level, negative-yielding debt peaked at over EUR18tr at the end of 2020; much of it based in the euro zone. Today that figure is down at USD1.7tr. In Mr. Steve Barrow’s view, the persistence of such large amounts of negative-yielding euro zone debt was putting off global investors and potentially detracting from the value of the euro as a result.

There have already been some signs that this could be changing, for while foreign investors sold a net EUR343bn of euro zone bonds in the year to September 2021, the subsequent twelve months through to September 2022 has seen a much smaller EUR124bn sold. Quite clearly it seems that there will have to be much more progress here for bond flows to really stand a chance of lifting the euro, but this lifting of debt out of the negative-rate universe does stand the region in good steady to see improving bond inflows over time.

Of course, other elements of the current account balance or the financial balance could work to offset whatever good news is going on in the debt market, but Mr. Steve Barrow doubts that this will happen and these flows will also support the euro. This being said, it does seem to be like trying to turn a super tanker when it comes to both the current/financial accounts and the euro.

“With this in mind, we are not saying that this prospect puts the euro on the cusp of an imminent and sharp rally. More likely is that the euro slowly turns around over time and, understandably, the points at which it might rally hard are more likely to be associated with notable events, like the end of the Fed’s tightening cycle, than any particular set of data relating to the current account”, said Mr. Steve Barrow.