Synopsis:

MUFG highlights that investor hedging dynamics will be a key driver of EUR/USD flows over the near term. While foreign inflows into Eurozone assets have resumed, the differing hedging costs and behaviors between USD- and EUR-based investors may cause asymmetrical FX effects.

Key Points:

• Hedging Incentives Diverge:
  USD-based investors are currently paid to hedge EUR exposure (i.e., positive carry), so they are more likely to hedge Eurozone bond purchases. In contrast, EUR-based investors face negative carry when hedging USD exposure, making them less inclined to hedge US fixed income purchases—leading to greater EUR-selling pressure.

• Equity Flows Less Hedged:
  Equity investments are typically less hedged than fixed income flows. The net equity inflows into the Eurozone are therefore more EUR-supportive compared to fixed income flows.

• Net Impact Still EUR-Positive:
  Despite potential EUR-negative effects from under-hedged USD bond buying, foreign investor return to Eurozone markets—especially equities—supports the EUR in the medium term.

Conclusion:

MUFG expects hedging behavior to amplify short-term EUR/USD volatility, with bond flows more likely to weigh on EUR, while equity flows support it. Overall, the resumption of capital inflows into the Eurozone should remain a structural tailwind for the euro, even if flow asymmetries cause tactical headwinds.