BNY’s Geoff Yu argues that the Euro (EUR) offers limited risk-reward compared with Eurozone assets as European Central Bank (ECB) policy pivots back toward growth. He notes EUR exposures are unusually high because hedge ratios have fallen sharply, even while equity and bond ownership remains subdued. Yu expects an ECB pullback to support Eurozone assets and drive a rebuilding of currency hedges rather than a sustained EUR rally.

Currency exposures outpace asset ownership

"The EUR is holding its ground heading into the ECB decision. There are already tentative signs of recovery, and we maintain the view that a pro-growth message from the ECB is far more beneficial to the Eurozone economy. Governing Council rhetoric is clearly shifting in that direction, with some major exceptions, and guidance in that direction would encourage further rotation back into the Eurozone."

"We remain cautious on chasing EUR outright, however. Our analysis indicates that current net EUR exposures are at the highest levels since 2024 and there has been decoupling in currency performance relative to ownership. By netting off the cross-border EUR holdings position (normally net short to reflect hedges) against changes in a standard 60:40 sovereign bond/equity portfolio, we can track the change in EUR exposures relative to portfolio performance."

"Recently net exposures have surged into positive, which is a rarity. This has been led by significant unwinding of EUR holdings relative to changes in portfolio holdings: current EUR hedges are 0.6x the rolling 12-month average, which is the lowest hedge level in our tracking period from 2024 onwards. Overall portfolio holdings are not high – equities are less than 2% above the rolling 12-month average and sovereign bonds 2% below (27th and 25th percentile respectively)."

"The ECB is unlikely to favor a significantly weaker EUR while residual inflation remains high. Any step back from tightening will be framed as just that and targeted at credit conditions. The German government’s complaints against CNH suggests concern over valuations against a Chinese shock."

"iFlow indicates that current EUR holdings strength is largely due to buying on the crosses (ex-EUR/GBP) due to the ECB’s recent hike, so a pullback will help avoid EUR exposures becoming excessive. Even with a more cautious growth outlook, the EUR has not fallen materially, which supports the view that holdings remain firm. Eurozone assets stand to benefit far more from an ECB pullback, and we expect hedge ratios to naturally increase."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor. Know more.)