It was less than three months ago that European Central Bank (ECB) President, Mario Draghi’s 60 billion euros per month bond purchase program came into effect. The ECB’s monetary stimulus appears to be achieving its objectives of combating deflationary pressures and reflating asset prices.
Admittedly, the euro’s descent started months ahead of the launch of the ECB’s quantitative easing (QE) program in March this year. The anticipation of a European QE, coupled with the U.S. tapering set the euro on the path of decline over a year ago.
In the last six months, the currency lost nearly 16 percent against the dollar. Since mid-January, when the size of the asset purchase program was announced, European equity markets surged, returning over 20 percent to investors.
The appreciation in the U.S. dollar has presented a tailwind for some, but a headwind for others. While one could logically surmise that a weaker euro should be positive for European companies (as it becomes cheaper for international customers to purchase European goods), the corporate business model is a bit more complex these days. To understand the currency impact on corporations and especially multinationals, we have to ask three questions: Where does the company derive its revenues? Where do they manufacture? Where do they source inputs and raw materials?
Where does the company derive its revenues?
European companies who derive a substantial part of their revenues outside the Euro-zone are benefitting from the translation effect of a weaker euro. Even if their overseas sales remained flat, the monetary value of sales when converted back to euros would result in a revenue uplift. Furthermore, for non-euro-based consumers, their products have become cheaper, ultimately leading to increased foreign demand.
The opposite is true for U.S. companies like Apple and Abercrombie & Fitch which derive over a quarter or more of their revenues from euro-based consumers.
Where do they manufacture and where do they source inputs and raw materials?
Despite the plunge in crude oil prices, some European-based oil and gas producers, like Total SA, are naturally able to protect revenues due to a weaker euro. The majority of the French company’s expenses, including salaries and rent are denominated in euros, while its revenues are derived from crude oil, a dollar denominated commodity.
Meanwhile, U.S. corporate behemoths like Caterpillar, General Electric and Emerson Electric are exploring ways to cut costs in order to remain competitive.
The Missouri-based Emerson Electric is considering increasing production in Mexico and Eastern Europe to safeguard against the strong U.S. dollar. Essentially, companies that source materials and inputs from currency-depressed locations will realize an immediate cost reduction.
For U.S. multinationals, another added benefit of eurozone QE has been lower borrowing costs in the region. With European bond yields at depressed levels, U.S.-domiciled companies have raised a record 49.8 billion euros of bonds this year, rushing to lock in low yields. Companies are keeping the funds in Europe to fund their European operations, a strategy which performs well as a natural hedge against currency fluctuations.
What does this mean for Europe?
According to Goldman Sachs Asset Management, 54 percent of aggregate European corporate revenues are being generated outside of Europe. While this bodes well for a eurozone economic recovery, the impact of a weaker euro does not benefit all companies equally. Likewise, the impact for EU member states is not equally distributed despite the fact that exports represent more than a quarter of Europe’s GDP. Countries like Germany which have a healthy and sizeable export business are better positioned than countries like Portugal and Spain with trade account deficits.
Despite some countries being better positioned to take advantage of the fall in the euro, this does not automatically translate into a blessing for all industries. European auto manufacturers and the tourism industry are poised to reap the benefits, according to a report published by Moody’s. The latter as a result of euro area destinations becoming cheaper for overseas travelers and the former due to the fact that the majority of their costs are in the euro area while sales are not.
The credit rating agency also points out that European airlines may be the biggest losers. Notwithstanding the expected increase in flight travel to Europe, it is expected that non-European airlines will be the ones to capture the increased demand.
In summary, it’s clear that a monetary policy meant to revive the eurozone and its 19 member states will result in different outcomes for individual countries, industries and companies. At least the ECB is making some headway in achieving its goals for the eurozone and investors who understand how European QE will affect various companies are better positioned to benefit from the results of the ECB’s accommodative monetary policy.
Disclaimer: The views expressed are the opinions of the writer and whilst believed reliable may differ from the views of Butterfield Bank (Cayman) Limited. The Bank accepts no liability for errors or actions taken on the basis of this information.