Replacing the yen as the new "financing currency"? Goldman Sachs and JPMorgan Chase both bearish on the euro

Goldman Sachs and Morgan Stanley believe that the euro's trend presents a good opportunity for arbitrage trading.

On January 29th, Beijing time, according to media reports, the expectation of a rate cut by the European Central Bank (ECB) has increased, putting heavy pressure on the euro and making it a "popular choice" for fund arbitrage. Goldman Sachs and Morgan Stanley suggest borrowing euros to purchase high-risk, high-yield currencies in order to seek interest rate differentials.

Asset management companies Allspring Global Investments (hereinafter referred to as Allspring) and 91 Asset Management (hereinafter referred to as 91 Asset Management) favor arbitrage trading in emerging market currencies to hedge against the euro. Allspring is also bearish on the euro against the US dollar.

Last Thursday, the ECB's interest rate meeting stopped raising rates for the third consecutive time, and Lagarde's overall stance leaned dovish, leading to an increase in market expectations of a rate cut. Analysts believe that the market is betting with more than a 90% probability that the ECB will start cutting rates in April.

The increasing expectation of a rate cut has cast a shadow over the euro, which performed the worst among G10 currencies last week. The market expects the eurozone's benchmark interest rate to fall to 2.5% by 2024, compared to 4% in the United States.

Over the past two years, the Bank of Japan's negative interest rate policy has led to a reduction in the cost of borrowing yen, and the yen exchange rate has fallen to its lowest level in decades. However, as the Bank of Japan gradually adopts a more hawkish stance, there is an increasing possibility that negative interest rates will end in March or April, and traders are looking for alternative funding currencies, with the euro coming into view.

The interest rate differential between Japan and the eurozone has narrowed, enhancing the euro's substitutability for financing.

Kamakshya Trivedi, Global Head of Currency, Rates, and Emerging Markets Strategy at Goldman Sachs, said, "The euro faces multiple pressures, including a weak German economy and sluggish private sector activity, but the euro is an 'attractive financing option'."

Lauren Van Biljon, Portfolio Manager at Allspring, said that compared to other G10 countries, Europe's economic growth is more fragile, which may create room for the ECB to cut rates ahead of the United States and the United Kingdom in the second quarter. Allspring has increased its short position on the euro against the US dollar in its global bond portfolio this month. The low volatility of the euro makes it a favored currency for Van Biljon in fund arbitrage.

Valentin Marinov, Head of G10 Currency Research at Credit Agricole CIB, said that clients have been discussing the possibility of shorting the euro against the Mexican peso, Brazilian real, and Indian rupee. "Once the policy cycles of the Bank of Japan and the ECB clearly diverge from the second quarter, these possibilities may become more attractive," he said.

Iain Cunningham, Head of Multi-Asset Growth at 91 Asset Management, said, "In the next 12 to 18 months, the position allocation in Europe and Japan is the most asymmetric." He is betting that the euro will fall against the yen. He has been using borrowed euros to buy Turkish lira, South African rand, and Chilean peso. "Compared to market expectations, the European Central Bank will have to implement loose monetary policy, while the Bank of Japan will implement tightening policy," he said.

Goldman Sachs is bearish on the euro against the Indian rupee, expecting the currency pair to fall by about 3% to 88 rupees. For higher-risk trades, they recommend selling euros and buying Mexican pesos and Brazilian reais.

According to Bloomberg data, the return on borrowing euros this month to buy high-yielding Argentine pesos is 8%, compared to 6% if using US dollars.

Meera Chandan, Co-Head of Global Foreign Exchange Strategy at JPMorgan, said, "As central banks around the world turn dovish, the euro is best used as a funding tool rather than a recovery candidate."