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Steady demand from European investors who have diversified their portfolios within the euro zone rather than beyond its borders may help explain why the euro is so strong, a Morgan Stanley currency strategist said.
However, Stephen Jen, global head of currency research at the US investment bank, said that could change when the economic conditions in the euro zone's 15 countries become more aligned, forcing domestic investors to look beyond the currency bloc to diversify. In a note to clients on Thursday, Jen said the euro was "grossly overvalued" and attributed its strength against other currencies to capital flows rather than economic fundamentals.
Much of those flows have come from overseas, particularly the United States and Asia. Jen said the $22 trillion US mutual fund industry's exposure to non-US assets has risen from 13 percent to 23 percent since 2003. That outflow has been an obvious drag on the US currency, and a similar decline in home bias among Japanese investors has weighed on the yen.
Jen said euro zone investors have been among the biggest and most loyal euro buyers in recent years, lending additional support to the currency. Since the euro was launched in 1999, the ratio of Europeans' investments in euro zone versus non-euro zone countries has climbed to 34 percent from 21 percent.

Copyright Reuters, 2008

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