The Euro: Ready for a Rebound?

Mid Week Bond Update

The Euro: Ready for a Rebound?

Despite the downbeat environment, sentiment and potential for fundamental improvement could work in the currency's favor.


U.S. dollar-denominated assets saw solid appreciation over the past year – as did the U.S. dollar itself[1],  with economic news for the period largely favorable to the U.S.

The euro, in contrast, has steadily eroded against other major currencies, joining as has the Brexit-beleaguered British pound over the past year.

But despite lagging growth and near-zero interest rates in the eurozone, there are reasons to consider the case for a rebound in the euro, on the basis of both fundamentals and contrarian sentiment.
 

Euro Area Net International Investment Position, 1999 – 2018

Chart: Eurozone: Current Account Balanc (% of GDP)

Chart courtesy of Brandywine Global. Source: Macrobond; data as of 12/31/2018.  Past performance is no guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

 

As noted by Brandywine Global, the eurozone is presently running a current account surplus, saving more than it invests. Over time, these recurring surpluses has helped improve the region’s net international investment position, and could push that net position into positive territory. That would, in turn, allow the eurozone to become a net supplier of capital to the rest of the world which would, over time, create increased demand for euro-denominated assets, and therefore, for the currency itself.

These are trends that would take years to unfold, and are unlikely to nudge the euro higher in the short run.  But given today’s deeply negative sentiment, even incremental improvements could set the stage for a contrarian rebound, eventually followed by a fundamentals-based trend.
 

On the rise: “Green” bonds

Demand for the recent issuance of 20-year “green” bonds by AAA-rated Netherlands far outstripped supply. The country's treasury department planned for an offering in the range €4- to €6-billion; the sale was met by more than €21 billion of orders. The final issued amount was €6 billion.

Bonds are considered “green” if a portion of their proceeds are earmarked for ecology-related projects.  In the case of the Netherlands bond issue, bidders for the bonds received preferential treatment if they could prove their ecological credentials, receiving an extra 10% of their requested allocation of bonds.  According to the issuer, 82.5% of the bids came from what it called “green real money accounts”. However, this class of investors accounted for only 28.5% of the bonds actually allocated in the auction.

This week’s issue wasn’t the first “green” sovereign bond, which was issued by Poland in 2016. However, the Netherlands offer was the first issue from a AAA-rated country, and the first to show a preference to “green” investors.
 

 On the slide: U.S. business tax intake

The Internal Revenue Service (IRS) 2018 “Data Book”  released this week showed tax collections from individuals and businesses of roughly $3.5 trillion 57% of that came from individuals and 33% from employment taxes. Another 2% or so came from estate, gift and excise taxes.

The remaining nearly 8% came from corporations, their lowest share since at least 1960. These figures weren’t adjusted for refunds to businesses, which amounted to some $60 billion, driving the net amount collected from businesses to some $203 billion, somewhat below 6%.

All data Source: Bloomberg as of May 21, 2019 unless otherwise specified.


1 Between May 21, 2018 and May 21, 2019, the dollar has risen 4.74% against a basket of other currencies; the Bloomberg Barclays U.S. Aggregate Bond Index has risen 6.35% over the same interval.

 

All data Source: Bloomberg as of May 21, 2019 unless otherwise specified.

Top

Important Information

 

All investments involve risk, including possible loss of principal.

The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested, and can be affected by changes in interest rates, in exchange rates, general market conditions, political, social and economic developments and other variable factors. Investment involves risks including but not limited to, possible delays in payments and loss of income or capital. Neither Legg Mason nor any of its affiliates guarantees any rate of return or the return of capital invested. 

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls.

International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.

Past performance is no guarantee of future results.  Please note that an investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice.  Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not take into account the particular investment objectives, financial situation or needs of individual investors.

The information in this material is confidential and proprietary and may not be used other than by the intended user. Neither Legg Mason or its affiliates or any of their officer or employee of Legg Mason accepts any liability whatsoever for any loss arising from any use of this material or its contents. This material may not be reproduced, distributed or published without prior written permission from Legg Mason. Distribution of this material may be restricted in certain jurisdictions. Any persons coming into possession of this material should seek advice for details of, and observe such restrictions (if any).

This material may have been prepared by an advisor or entity affiliated with an entity mentioned below through common control and ownership by Legg Mason, Inc.  Unless otherwise noted the “$” (dollar sign) represents U.S. Dollars.

This material is approved for distribution in those countries and to those recipients listed below. Note: this material may not be available in all regions listed.

All investors and eligible counterparties in Europe, the UK, Switzerland:

In Europe (excluding UK and Switzerland), this financial promotion is issued by Legg Mason Investments (Ireland) Limited, registered office 6th Floor, Building Three, Number One Ballsbridge, 126 Pembroke Road, Ballsbridge, Dublin 4, D04 EP27. Registered in Ireland, Company No. 271887. Authorised and regulated by the Central Bank of Ireland.

All Qualified Investors in Switzerland:
In Switzerland, this financial promotion is issued by Legg Mason Investments (Switzerland) GmbH, authorised by the Swiss Financial Market Supervisory Authority FINMA.  Investors in Switzerland: The representative in Switzerland is FIRST INDEPENDENT FUND SERVICES LTD., Klausstrasse 33, 8008 Zurich, Switzerland and the paying agent in Switzerland is NPB Neue Privat Bank AG, Limmatquai 1, 8024 Zurich, Switzerland. Copies of the Articles of Association, the Prospectus, the Key Investor Information documents and the annual and semi-annual reports of the Company may be obtained free of charge from the representative in Switzerland.

All investors in the UK:
In the UK this financial promotion is issued by Legg Mason Investments (Europe) Limited, registered office 201 Bishopsgate, London EC2M 3AB. Registered in England and Wales, Company No. 1732037. Authorized and regulated by the Financial Conduct Authority. Client Services +44 (0)207 070 7444

All Investors in Hong Kong and Singapore:

This material is provided by Legg Mason Asset Management Hong Kong Limited in Hong Kong and Legg Mason Asset Management Singapore Pte. Limited (Registration Number (UEN): 200007942R) in Singapore.

This material has not been reviewed by any regulatory authority in Hong Kong or Singapore.

All Investors in the People’s Republic of China ("PRC"):

This material is provided by Legg Mason Asset Management Hong Kong Limited to intended recipients in the PRC.  The content of this document is only for Press or the PRC investors investing in the QDII Product offered by PRC’s commercial bank in accordance with the regulation of China Banking Regulatory Commission.  Investors should read the offering document prior to any subscription.  Please seek advice from PRC’s commercial banks and/or other professional advisors, if necessary. Please note that Legg Mason and its affiliates are the Managers of the offshore funds invested by QDII Products only.  Legg Mason and its affiliates are not authorized by any regulatory authority to conduct business or investment activities in China.

This material has not been reviewed by any regulatory authority in the PRC.

Distributors and existing investors in Korea and Distributors in Taiwan:

This material is provided by Legg Mason Asset Management Hong Kong Limited to eligible recipients in Korea and by Legg Mason Investments (Taiwan) Limited (Registration Number: (98) Jin Guan Tou Gu Xin Zi Di 001; Address: Suite E, 55F, Taipei 101 Tower, 7, Xin Yi Road, Section 5, Taipei 110, Taiwan, R.O.C.; Tel: (886) 2-8722 1666) in Taiwan. Legg Mason Investments (Taiwan) Limited operates and manages its business independently.

This material has not been reviewed by any regulatory authority in Korea or Taiwan.

All Investors in the Americas:

This material is provided by Legg Mason Investor Services LLC, a U.S. registered Broker-Dealer, which includes Legg Mason Americas International. Legg Mason Investor Services, LLC, Member FINRA/SIPC, and all entities mentioned are subsidiaries of Legg Mason, Inc.

All Investors in Australia:

This material is issued by Legg Mason Asset Management Australia Limited (ABN 76 004 835 839, AFSL 204827) (“Legg Mason”). The contents are proprietary and confidential and intended solely for the use of Legg Mason and the clients or prospective clients to whom it has been delivered. It is not to be reproduced or distributed to any other person except to the client’s professional advisers.

Forecasts are inherently limited and should not be relied upon as indicators of actual or future performance.