Eurozone portfolio debt inflows resume

The portfolio outflows that accompanied QE are reversing

IN 2017, then-ECB Executive Board member Benoît Cœuré reflected on the “international dimension of the ECB’s asset purchase program” by noticing that the “APP… appear[s] to have triggered substantial capital flows across borders.”

To illustrate the point, Cœuré included a chart of Eurozone net portfolio flows, as copied below, which showed substantial net outflows (represented as a positive in the below chart) coincident with the initiation of the APP in 2015. He noted:

“At their peak around the middle of 2016, net capital outflows – measured here in terms of 12-month moving sums – reached nearly 5% of euro area GDP. Never before in the history of the euro area have capital flows been so high.”

Cœuré then notes the different contributions of domestic and foreign investors to this net flow at that time. Net outflows by domestic investors saw rotation into long-term fixed income securities in safe havens, whereas the net flows from non-residents was largely flat as equity inflows were matched by outflows from portfolio debt—a rotation by non-residents from fixed income to equity securities.

Whatever the driver, this net portfolio flow was coincident with a weakening of the euro exchange rate—and rather suggestive that central bank balance sheet management can have a substantial balance of payments impact.

Since the post-pandemic rate normalisation, interrupting a decade close to the zero lower bound, balance sheet contraction across the major economies has begun.

For the Eurozone, this may have equally profound implications for capital flows as during the balance sheet expansion phase noted by Cœuré.

Eurosystem plumbing

Indeed, non-resident inflows to Eurozone long-term portfolio debt have picked up markedly over the past year, reversing a period of outflows (associated with APP/PEPP). For example, LT portfolio inflows (left chart) averaged about EUR40bn over the past 3 months, larger than equivalent outflows (right).

But there is an important “plumbing” nuance worth disposing with here.

Part of the inflow in the past 2 years reflects the recycling of euro deposits held with the Eurosystem, presumed by reserve managers, back into govvies. This does not create a demand for euros therefore as asset managers already have the cash. For example, non-resident euro deposits with the Eurosystem were about EUR200bn pre-pandemic though increased to above EUR400bn in 2021 (ignoring the end-quarter noise due to repo activities.)

It is believed that reserve managers get the depo rate minus 15bps on their deposits with National Central Banks (Bundesbank being a preferred reserve manager.)  As such, if the yield on Eurozone “safe” govvies rise above depo minus 15bps, reserve managers should allocate from these deposits into govvies.

The chart below shows these euro deposits with the Eurosystem (left) as well as the yield on the 3Y tenor for France, Germany and Italy (right).

During 2022 and the first half of 2023, such safe assets would have been attractive for reserve managers once more as the front end of the yield curve moved above the adjusted deposit rate. Hence some of the non-resident inflow to govvies during this period was likely this recycling. Crucially, this flow would not create any new demand for euros.

But these deposits have levelled off recently just below EUR200bn, perhaps because the yield on safe assets have fallen again relative to the deposit rate. (It is also possible that some CBR assets are encumbered there, creating a price-insensitive lower bound.)

Portfolio return

Whatever the cause of the levelling off of these non-resident deposits, this implies that much of the recent inflow into Eurozone portfolio debt cannot be attributed to such deposit recycling—and instead reflects new non-resident demand for portfolio assets.

The chart below shows this as it nets from portfolio flows to general government portfolio debt the other investment claims on the Eurosystem (deposits). And over the past few months, such net flows have picked up to above EUR30bn per month—meaning the demand for euros for such portfolio debt has increased.

This is the reserve of the non-resident portfolio outflow noted by Cœuré at the time of the initial APP in 2015, providing an important source of demand for euro assets that could continue as downward balance sheet management continues.

The content in this piece is partly based on proprietary analysis that Exante Data does for institutional clients as part of its full macro strategy and flow analytics services. The content offered here differs significantly from Exante Data’s full service and is less technical as it aims to provide a more medium-term policy relevant perspective. The opinions and analytics expressed in this piece are those of the author alone and may not be those of Exante Data Inc. or Exante Advisors LLC. The content of this piece and the opinions expressed herein are independent of any work Exante Data Inc. or Exante Advisors LLC does and communicates to its clients.

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