Balance-of-payments data show that euro-area residents purchased €36 billion of foreign bonds in November. This continues a trend that started in the first half of last year and gained pace after the European Central Bank (ECB) cut its deposit rate into negative territory in June. Between June and November 2014, euro-area residents bought €200 billion of foreign bonds (Display 1). This compares with €33 billion in the same period a year earlier and is the strongest outflow since the financial crisis struck.

The chief beneficiaries of these outflows have been the US and the UK. According to quarterly data from the ECB, euroarea residents bought €77.8 billion and €37.0 billion respectively of US and UK debt securities in the second and third quarters of 2014. These two countries accounted for roughly two-thirds of all foreign-bond purchases during this period (Display 2).

QE Accelerant

Looking ahead, there is every reason to expect euro-area residents to continue buying large quantities of foreign bonds. Last week, the ECB announced that from March this year until September 2016, it intends to buy €60 billion per month of public and private sector debt securities. Moreover, it plans to do this at a time when interest rates in the euro area are already at incredibly low levels—not only is the ECB’s deposit rate negative, but so too are short-dated bond yields in core Europe.

Against this backdrop, there is little doubt that much of the liquidity injected by the ECB will flow into overseas markets. And while the US and UK might be the first ports of call, other higher-yielding markets are also likely to benefit. Quantitative easing (QE) in the euro area is therefore likely to exert considerable downward pressure on global bond yields.

Bond Flows Swamp Current Account

Bond outflows from the euro area are also likely to have implications for exchange rates. For all the region’s difficulties, the euro had, until recently, remained strong. One of the main reasons for this was a large and rising current account surplus— in much the same way that Japan’s huge current account surplus supported the yen during the 1990s.

While its strong current account position continues to represent an important source of structural support for the euro, the overall balance of payments looks much less favorable. Between June and November 2014, the euro area’s current account surplus was €147 billion, or 2.4% of gross domestic product in seasonally adjusted terms. At the same time, the region also benefited from a net equity inflow of €113 billion. However, all other components of the balance of payments showed net outflows during this period.

As Display 3 shows, between June and November last year, net direct investment in the euro area was minus €43 billion and net banking flows were also negative (to the tune of €61 billion). But the biggest outflow was via the bond channel. With euro-area residents gobbling up €200 billion of foreign bonds and overseas residents off-loading €42 billion of euro-area bonds (the strongest sales by foreigners since the height of the sovereign-debt crisis), net bond outflows from the euro area reached €242 billion between June and November last year.

In our view, the current account is likely to be a positive factor for the euro for some time to come. Moreover, an improving cyclical backdrop and weaker currency could continue to attract equity—and, in time, direct investment—inflows into the region. But with short-term interest rates negative and the ECB about to embark upon a large-scale asset-purchase program, the euro is likely to face a formidable headwind in the form of continued large bond outflows.

By Darren Williams, Senior European Economist—Global Economic Research and Dennis Shen, Economic Associate—Global Economic Research, AllianceBernstein

————-

The information contained herein reflects the views of AllianceBernstein L.P. or its affiliates and sources it believes are reliable as of the date of this publication. AllianceBernstein L.P. makes no representations or warranties concerning the accuracy of any data. There is no guarantee that any projection, forecast or opinion in this material will be realized. Past performance does not guarantee future results. The views expressed herein may change at any time after the date of this publication. This document is for informational purposes only and does not constitute investment advice. AllianceBernstein L.P. does not provide tax, legal or accounting advice. It does not take an investor’s personal investment objectives or financial situation into account; investors should discuss their individual circumstances with appropriate professionals before making any decisions. This information should not be construed as sales or marketing material or an offer or solicitation for the purchase or sale of any financial instrument, product or service sponsored by AllianceBernstein or its affiliates. Note to Canadian Readers: AllianceBernstein provides its investment management services in Canada through its affiliates Sanford C. Bernstein & Co., LLC and AllianceBernstein Canada, Inc. This document has been issued by AllianceBernstein Australia Limited (ABN 53 095 022 718 and AFSL 230698). Information in this document is only intended for persons that qualify as “wholesale clients,” as defined in the Corporations Act 2001 (Cth of Australia), and should not be construed as advice.

The post Bond outflows weigh on the Euro appeared first on AdviserVoice.