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The weakening currency makes European assets more attractive.
Andrew Sawers, CFO Magazine
August 1, 2012
With the euro hitting record lows against the U.S. dollar, currency analysts are getting out their rulers to see how far they can extrapolate the downward trend. Corporate strategists, meanwhile, are eyeing ever more affordable European targets for acquisition.
The euro touched $1.23 at the beginning of June, down from this year's high of $1.35 at the beginning of March. That drop has prompted some foreign-exchange experts to say they can't rule out the possibility of the euro hitting parity with the dollar if Greece leaves the single European currency. (Most experts agree that parity following a so-called Grexit would be an extreme scenario. More likely, they believe, would be a fall of about 10 cents from current levels.)
David Woo, head of global rates and currencies research at Bank of America Merrill Lynch, predicts the euro will continue to slide to around $1.20, then start recovering toward $1.30 by year-end. He argues that the situation will have to deteriorate further before either Europe or the United States issues any aggressive policies in response. "The only thing that can stem the dollar's rise is very aggressive monetary easing from the Fed," he says. "I don't think that's on the cards until things get worse."
Still, while the euro may not be a particularly cheap currency at the moment, underlying European assets are cheap, Woo says. Not only is the dividend yield of the Eurostoxx 50 index significantly above that of the S&P 500, "the differential is now literally two standard deviations" from the historical norm, he says. Moreover, the fact that Spanish government bond yields are at 6.5% or more, compared with 1.5% yields for 10-year U.S. Treasuries, means the market "is basically discounting an almost 60% devaluation of Spain over the next 10 years," Woo says.
As the price of European assets continues to slide, U.S. companies are starting to consider acquisitions in Europe, Woo says. "These assets are starting to look really attractive," he says. "They can purchase European companies more cheaply than at any time over the last 10 years." In March, for example, UPS agreed to acquire Dutch group TNT Express for €5.2 billion ($6.5 billion). In April, Watson Pharmaceutical sealed a deal for Actavis for €4.25 billion from Deutsche Bank, which took control of the indebted group in 2008.
Of course, if sentiment improves, or if Europe introduces a policy to reduce the risk premium for European assets, the euro might get a boost as money flows in to scoop up European assets, Woo adds.
Andrew Sawers is editor of CFO European Briefing, a CFO online publication.