UK eyes 'major trade deal'

Europe may be better prepared to absorb a seismic shift in global investment flows than many assume, as a number of regulatory twists are set to bolster euro market depth.

U.S. President Donald Trump's unilateral redrawing of world trade rules is raising the question of whether giant U.S. capital surpluses will have to unwind if tariff hikes succeed in squeezing America's persistent trade deficits.

For macro-economists, those are two sides of the same coin.

If the administration succeeds in rebalancing the U.S. economy, defusing dollar over-valuation and regaining the country's manufacturing edge, that will have to involve some shrinkage of the roughly $26 trillion U.S. Net International Investment Position, the excess of foreign capital in U.S. assets over U.S. investments overseas.

During March and April, there was considerable concern that foreign capital flight was indeed underway as U.S. stocks, bonds and the dollar fell in tandem. The sell-off was driven by mounting anxiety about the potential for a self-inflicted U.S. recession or stagflation, fraying U.S. institutions and the dollar's role as a safe haven.

At the same time, the euro and euro stocks soared, in part due to Germany's equally dramatic new spending and borrowing plans that refired hopes for longer-term growth and an expanded pool of high-quality debt assets.

But doubts lingered about whether Europe's smaller and shallower capital markets could ever accommodate a repatriation of the deluge of savings that have poured into U.S. assets over the past decade-plus. Some $7 trillion in European savings has flocked to Wall Street equities since 2012.

Graphics are produced by Reuters.

Indeed, many reckon American markets attracted such vast sums as much because of their unrivalled scale and liquidity as any 'exceptional' American economic or corporate performance per se. In turn, the euro's smaller and more fragmented markets have raised doubts about whether the currency could ever challenge the dollar's wide usage.

Actual fund flow data supports the idea that capital is being pulled back across the Atlantic.

Mutual funds tracked by EPFR show that the second week in February saw net U.S. equity fund redemptions for the first time this year. That's only the ninth weekly outflow in 12 months. U.S. growth funds have seen five straight weeks of outflows.

Indeed, many reckon American markets attracted such vast sums as much because of their unrivalled scale and liquidity as any 'exceptional' American economic or corporate performance per se. In turn, the euro's smaller and more fragmented markets have raised doubts about whether the currency could ever challenge the dollar's wide usage.

Graphics are produced by Reuters.

The Bank of England is on Thursday expected to nudge its main interest rate below the Federal Reserve's key rate for the first time since August. This will restore the U.S. rate premium that's existed in all but a brief period over the past decade. Markets now expect three more cuts from both central banks over the remainder of the year. 

However, after a fresh wobble in British government bond yields earlier this year, 10-year gilt yields are now almost 20 basis points above U.S. Treasury equivalents, though that gap has roughly halved in the past month.

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