By Charles Ross, ContributorHERE IN Jamaica when we think about cross-currency diversification, most of us tend to think mainly of holding the US dollar as a currency hedge, with a small minority looking at UK pounds sterling as an alternative currency for some of their investments. However, with the advent in January 1999 of the euro- the European Union's (EU) single currency another major international currency has emerged to rival the US dollar.
The euro was initially issued as an electronic currency and it was not until January 2002 that notes and coins became available in the 12 countries of the EU that use the currency. It is important to note that the absence of physical notes did not stop trading in the euro currency, nor did it prevent companies and countries from issuing bonds denominated in euros.
What may be of particular interest to investors is the movement in the value of the euro versus the US dollar since its inception in 1999. At issue, one euro was worth about US$1.18, but its value declined fairly steadily to a low of about US$0.83 in October 2000. Concerted central bank intervention raised the value of the currency to about US$0.95 by January 2001 but by July of that year it had again fallen to about US$0.85. The euro started a bumpy recovery in the latter half of 2001 and since the beginning of 2002, it has enjoyed a fairly steady and strong appreciation in value against the US dollar peaking at US$1.19 in May 2003. This represents a three per cent appreciation from its level at the beginning of 2002 and a 40 per cent gain on its low point in July 2001. In other words, an investor from a US dollar-linked currency zone who bought a euro denominated bond at the beginning of last year would have made a return in US dollars of over 30 per cent on his investment from the movement in the value of the currency alone.
CAPITALISING ON THE EURO'S STRENGTH
Persons who wish to take advantage of the euro's strength but do not wish to trade in the currency itself, can buy bonds denominated in euros. A wide range of countries and companies issue such bonds and there are many that trade on the international capital market in the same way that US dollar denominated bonds do. Bonds are also issued by countries and companies that have diverse credit ratings from those boasting AAA ratings, to emerging market countries such as Jamaica, Brazil and Mexico. The euro bonds trade in much the same way as the US dollar denominated bonds, except that most of the sovereign bonds carry an annual coupon. This makes them a little more expensive to buy on the secondary market and hence they tend to trade at slightly higher yields than the US dollar bonds of a similar rating or issuer. There is also a well-developed market in corporate bonds which is aimed directly at the retail client and offer very attractive yields for short to medium term investments.
One of the big questions surrounding cross currency investments in euros at the present time is whether that currency will continue to appreciate against the US dollar. As usual, opinions are divided as to what is the likely outcome. Those who are very bullish on the euro see it continuing to gain ground on the US dollar and perhaps rising to as high as US$1.30. The more cautious analysts see the currency settling at around US$1.20 for some time, before giving up some of the ground that it has gained against the dollar. These analysts see the possibility of this happening as soon as the last quarter of 2003. The bottom line is that the euro has had such a long rally against the US dollar that one should be quite cautious about taking a medium term speculative position in euros. In another article, we will look at some of the factors that will affect the future movement of the euro against the US dollar.
Charles Ross is Managing Director of Sterling Asset Management Ltd. Please send feedback to sterlingasset@jamweb.net
