(Bloomberg) -- The euro is encroaching on the dollar’s territory as the world’s currency of global borrowing, but that doesn’t mean anyone wants to keep hold of it.
“No one wants to hold euro cash as an asset anymore but everyone wants it as a liability,” George Saravelos, Deutsche Bank AG’s global head of currency research, wrote in a note. As a result, the euro zone “is emerging as the new global provider of liquidity to the international financial system, slowly replacing the dollar,” he said.
The common currency is increasingly being used in international borrowing, inter-bank funding and cross-border carry trades. This helps subdue the euro during periods of risk appetite, but could contribute to volatility and a rise in the currency when risk aversion returns.
The carry trade involves borrowing in a low-yielding currency and putting the money into others with higher interest rates, or other assets with stronger returns. It works well when volatility is low.
Euro-funded carry trades resulted in returns for all but three of the 23 emerging-market currencies tracked by Bloomberg, compared with 10 for dollar-funded trades.
Still, Goldman Sachs Group Inc. has suggested certain dollar-neutral carry trades on the possibility the global economy will steady.
The euro has fallen more than 3% this year and volatility in the euro-dollar pair hit record lows late last month. The lack of price swings has been attributed to steady monetary policy outlook at the European Central Bank and the Federal Reserve, as well as fading recession fears.
Deutsche Bank’s Saravelos argues that outflows based on the increased use of the euro as a funding currency for liabilities are keeping the currency subdued when risk appetite is high. The euro should have been appreciating against the dollar and moving closer to $1.40 over the last two years, he added. The common currency declined 0.1% on Wednesday to $1.1076.
“Despite the huge swing in the external accounts, the euro has stayed weak,” he said. “This is unprecedented.”
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