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Impact Investing

IPE special report May 2018

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Euro successes and failures

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Last year will be remembered as the year the euro was launched, and the year it fell miserably against other major currencies. Apart from its all too public depreciation and humiliation, the euro’s introduction has been deemed a wonderful success by borrowers, and ultimately lenders, and by investors too.
According to Capital Data, about $600bn(e594bn) of euro-denominated bonds were issued, representing some 44% of total international bond market issuance in 1999. What is most interesting is that euro-denominated issuance was higher, by some $25bn, than borrowings in dollars. In 1998, for example US dollar denominated bonds accounted for 48% of issuance while the combined Euro-11 issuancewas only 35%.
In a recent study from Salomon Smith Barney, Graham Bishop examines the phenomenal growth in the euro bond market over last year and suggests that it may be heralding a big change for global capital markets. He writes, “The appearance of the euro-denominated financial markets may offer, for the first time in a generation, a practical alternative haven for funds, if foreigners should grow nervous of financing US growth.” Although Bishop does argue for some patience pointing out that the process is still has far to go, he remains enthusiastic about its prospects: “The progress made in developing the euro-capital markets during 1999 suggests that investors may have an effective choice sooner than many commentators expect.”
Deutsche Bank Global Markets Research point out that if capital market liquidity is improved, then that should be seen as positive for an exchange rate. It argues that if Germany goes ahead with its proposed tax changes, for example, which include cutting corporate taxes on earnings and abolishing certain capital gains taxation, the resulting improvement in capital allocation should make it easier for German firms to engage in more M&A activity and thence greater foreign investment flows into Germany, and that would be ultimately be positive for the euro’s real long-term equilibrium value. They conclude, “The planned tax reforms go some way towards addressing concerns about Euroland’s long-term competitiveness and its ability to attract international investment capital, and as such provides a structural element to the current improvement in euro sentiment.’
Murray Johnstone’s Rod Davidson is slightly more sceptical, and cautions against too much enthusiasm too soon. “Don’t get me wrong,” he says, “I am a fan of the euro, and am in favour of sterling joining it. However, we have few hurdles to jump before the euro does indeed become an attractive alternative. I would argue that the Greek drachma’s imminent arrival should be seen as a diminution of the euro’s quality, even if the drachma has just been re-, as opposed to de-valued! Greece will be viewed as a weak member and I’m sure will have a negative pull on the perceived strength of the euro. The US authorities are not too keen on their currency being ‘diluted’, in effect by Argentina or Ecuador joining in.”
JP Morgan’s Harriett Richmond is similarly keen to rein back unchecked enthusiasm for the brave new market. She states, “I do think the euro as a store of value argument will turn out to be correct in the long run, but would add that we, as investors tend to be a fairly fickle lot and I think it will take at least a full economic cycle before we are all convinced of the euro’s powers.” Richmond suggests that until the euro is ready to be accept, that the likes of the Swiss franc and, ironically, EMU-avoider sterling will continue to attract that kind of safe haven flow.
Richmond suggests that the demand for high yield/investment grade markets is probably there already, with many European investors – more used to receiving double-digit yields on their deposits and cash instruments than the current 2–3% – looking to put their cash elsewhere. Spanish and Italian funds in particular have been huge buyers of both European and US equities. She concludes, “In the end it will be economic fundamentals that determine how well the euro will be received. It took many years, decades, to build up the depth and breadth of the US bond markets, and we cannot reasonably expect it to happen within just a couple of years here, even with the wonders of the internet!” Caroline Hay

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