Analysts have highlighted the euro’s potential as the prime candidate for funding carry trades due to its relatively higher yield, as the yen's long reign as the go-to funding currency may end with the Bank of Japan or BoJ hinting at a future rate hike.
Major Wall Street banks, including Goldman Sachs and JPMorgan, are advocating borrowing euros to invest in emerging market currencies with higher yields. Some asset managers like Allspring Global Investments and Ninety One also favor the trade, although Allspring also expects further depreciation of the euro against the U.S. dollar.
Goldman Sachs predicts the euro to drop around three percent against the Indian rupee to 88 rupees. For bolder investors, the bank suggests trading the euro for the Mexican peso and Brazilian real.
Analysts at JPMorgan echo this sentiment, viewing the euro as "a funder rather than a recovery candidate as central banks turn dovish." They also paint a dim picture for the euro, citing robust U.S. economic growth, escalating geopolitical tensions, and internal eurozone struggles as roadblocks to its recovery.
This headwind comes on top of a rough start to the year, with the currency already down 1.6 percent since January 1. As of writing, the EUR/USD pair has fallen by 0.08 percent to 1.0843.
Early signs suggest success for euro-funded carry trades into high-yielding currencies like the Argentine peso. According to data compiled by Bloomberg, investors made an 8.0 percent return this month for borrowing euros and buying the peso, compared to six percent with the dollar. Against the yen, the strategy delivered an even higher return of 11 percent.
Valentin Marinov, the head of G-10 currency research at Credit Agricole CIB, told Bloomberg his clients were considering shorting the euro against the Mexican peso, the Brazilian real, and the rupee. He noted that this strategy might gain more attractiveness as the policy cycles of the BoJ and the European Central Bank (ECB) begin to significantly diverge starting in Q2.
In contrast, Ugo Lancioni of Neuberger Berman and Michael Sager of CIBC Asset Management argue that alternatives to the euro offer better prospects. Both endorse the Swiss franc, with Sager additionally recommending the Chinese renminbi. However, as the interest rate gap between Japan and Europe narrows, a shift from the yen to the euro is highly likely.
Rate cuts on the horizon
Expectations for earlier easing by the ECB gained momentum this week after President Christine Lagarde's comments hinted at a potential shift in policy. This pushed the euro to the worst weekly performance among its G-10 peers.
While reiterating her previous position on rate cuts, Lagarde also acknowledged weakening economic indicators on Thursday. Her comments on slowing growth, easing wage pressures and persistent disinflation fuelled market expectations for an April rate cut, with investors nearly fully pricing in a quarter-point reduction. The key interest rate in the euro area is projected to finish 2024 around 2.5 percent, significantly lower than the four percent expected for the United States.
“Growth in Europe feels more precarious than elsewhere in G-10,” said Lauren Van Biljon, portfolio manager at Allspring, as quoted by Bloomberg. This economic condition “could create space for the ECB to cut in the second quarter, ahead of the U.S. and the U.K.”
Adding to the speculation is ECB official Francois Villeroy de Galhau, who hinted at possible interest-rate cuts at any upcoming meetings in an interview with the French newspaper La Tribune Dimanche.
"Regarding the exact date, not one is excluded, and everything will be open at our next meetings,” he said.
Joining the Frenchman, Portugal's Mario Centeno suggested a potential action before May, while Gediminas Simkus expressed openness to an April step and willingness to assess incoming data in the interim.