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The early 2020 dip in EUR/USD, to its lowest level since April 2017, did not prove to be the sustained break higher in the USD that some had anticipated, with the move aggressively unwinding over the course of the following week. The rush to close overweight USD positions helped drive the move, with the latest leg lower in the USD coming as a result of the intra meeting Fed rate cut.
There are several reasons why the USD had appeared relatively attractive coming into 2020. Of note, higher yields on US assets and negative rates in the eurozone enticed market participants into the carry trade. However, the coronavirus led to rising expectations of a Fed rate cut – which arrived on Tuesday (3 March), crushing carry and with it the appeal of the USD.
Investors had also been positioned for a stronger USD for reasons other than carry. At the start of the coronavirus outbreak, markets became convinced that the US was less economically exposed to China than Europe. This reinforced the market view that the USD was a safe haven currency. However, with the virus epidemic now spreading more rapidly outside of China, assumptions that it will have only a moderate impact on US growth have been cast aside.
Figure 1: Spread in 1-Year Forward 1-Month USD and EUR OIS
Source: Bloomberg Finance L.P., as of 3 March 2020.
The Fed as the driver
The gap between the 1-year forward of the 1-month OIS (Overnight Index Swap) in USD and EUR, a proxy for central bank rate expectations over the coming 12 months, has narrowed aggressively (Figure 1) and, at 117bp, is at its tightest since November 2016. The Fed may have delivered an emergency cut but markets remain priced for a further 75bp of easing by the end of 2020. Even if this proves overly aggressive, a rebound in the USD is far from given, for two main reasons:
It looks unlikely that there will be a rush to reset long USD carry trades: these are for less volatile times.
While economic weakness persists, investors are unlikely to favour the USD given that scope for the Fed to cut remains far greater than for the ECB.
The FX forward curve already prices a gradual appreciation in EUR/USD to over 1.1350 over the coming year (Figure 2) which, if realised, implies a drag of around 1.5% on USD portfolio performance for EUR-based investors.
Figure 2: Forwards Price a Rise in EUR/USD
Source: Bloomberg Finance L.P., as of 3 March 2020.
In conclusion, with the USD’s winning streak having come to such a dramatic end, EUR-based investors can no longer rely on a stronger USD to support asset market performance. For this reason, now may be the time to consider hedging USD exposures back to EUR. There are a suite of SPDR funds that offer the ability to hedge:
Source: Bloomberg Finance L.P., as of 28 February 2020.
Marketing Communication. For Professional Client Use Only.
For Investors in Austria: The offering of SPDR ETFs by the Company has been notified to the Financial Markets Authority (FMA) in accordance with section 139 of the Austrian Investment Funds Act. Prospective investors may obtain the current sales Prospectus, the articles of incorporation, the KIID as well as the latest annual and semi-annual report free of charge from State Street Global Advisors GmbH, Brienner Strasse 59, D-80333 Munich. T: +49 (0)89-55878-400. F+49 (0)89-55878-440. Finland: The offering of funds by the Companies has been notified to the Financial Supervision Authority in accordance with Section 127 of the Act on Common Funds (29.1.1999/48) and by virtue of confirmation from the Financial Supervision Authority the Companies may publicly distribute their Shares in Finland. Certain information and documents that the Companies must publish in Ireland pursuant to applicable Irish law are translated into Finnish and are available for Finnish investors by contacting State Street Custodial Services (Ireland) Limited, 78 Sir John Rogerson’s Quay, Dublin 2, Ireland. France: This document does not constitute an offer or request to purchase shares in the Companies. Any subscription for shares shall be ade in accordance with the terms and conditions specified in the complete Prospectuses, the KIID, the addenda as well as the Companies’ Supplements. These documents are available from the Company centralising correspondent: State Street Banque S.A., 23-25 rue Delariviere- Lefoullon, 92064 Paris La Defense Cedex or on the French part of the site spdrs.com. The Companies re undertakings for collective investment in transferable securities (UCITS) governed by Irish law and accredited by the Central Bank of Ireland as a UCITS n accordance with European Regulations. European Directive no. 2014/91/ EU dated 23 July 2014 on UCITS, as amended, established common rules pursuant to the cross-border marketing of UCITS with which they duly comply. This common base does not exclude differentiated implementation. This is why a European UCITS can be sold in France even though its activity does not comply with rules identical to those governing the approval of this type of product in France. The offering of these compartments has been notified to the Autorité des Marchés Financiers (AMF) in accordance with article L214- 2-2 of the French Monetary and Financial Code. Germany: The offering of SPDR ETFs by the Companies has been notified to the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) in accordance with section 312 of the German Investment Act. Prospective investors may obtain the current sales Prospectuses, the articles of incorporation, the KIIDs as well as the latest annual and semiannual report free of charge from State Street Global Advisors GmbH, Brienner Strasse 59, D-80333 Munich. T: +49 (0)89-55878-400.
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Spain: State Street Global Advisors SPDR ETFs Europe I and II plc have been authorised for public distribution in Spain and are registered with the Spanish Securities Market Commission (Comisión Nacional del Mercado de Valores) under no.1244 and no.1242. Before investing, investors may obtain a copy of the Prospectus and Key Investor Information Documents, the Marketing Memoranda, the fund rules or instruments of incorporation as well as the annual and semi-annual reports of State Street Global Advisors SPDR ETFs Europe I and II plc from Cecabank, S.A. Alcalá 27, 28014 Madrid (Spain) who is the Spanish Representative, Paying Agent and distributor in Spain or at spdrs.com. The authorised Spanish distributor of State Street Global Advisors SPDR ETFs is available on the website of the Securities Market Commission (Comisión Nacional del Mercado de Valores). United Kingdom: The Companies are recognised schemes under Section 264 of the Financial Services and Markets Act 2000 (“the Act”) and are directed at ‘professional clients’ in the UK (within the meaning of the rules of the Act) who are deemed both knowledgeable and experienced in matters relating to investments. The products and services to which this communication relates are only available to such persons and persons of any other description should not rely on this communication. Many of the protections provided by the UK regulatory system do not apply to the operation of the Companies, and compensation will not be available under the UK Financial Services Compensation Scheme.
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Information related to Mexico
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