September 22, 2011
Euro Loses Crucial Prop as Central Banks Turn Sellers
The gravity-defying euro could be about to crash down to earth now that central banks in the developing world have turned into natural sellers of the single currency.
Having previously snapped up euros as they diversified vast amounts of dollars accumulated through trade and market intervention, and tried to maintain a steady euro weighting in their reserves, these central banks have done an about-face this week, particularly in Asia.
On Wednesday, they were buying dollars against the euro, having sold them against their own currencies, as panic swept global financial markets and foreign investors piled out of emerging-market investments in a general scramble for dollars, traders said.
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"This translates into less underlying support for the euro and makes it more sensitive to negative data," said Ian Stannard, head of European currency strategy at Morgan Stanley, citing the day's raft of weak economic surveys, which compounded fears of slowing economic growth in Europe at a time when Greek default worries are at a shrill pitch.
"Central banks have fewer dollars to sell and fewer euros to buy," he said.
As a result, the euro has lost a crucial prop of support—one that helped the currency perform well through much of 2011, even as the euro-zone debt crisis escalated. Having closed the first half of the year some 8% stronger against the dollar, rising to a high of $1.4940 on May 4, the euro has lost about 10 U.S. cents so far in September, hitting a seven-month low below $1.35. The currency pair was trading at $1.3449 in early New York trade.
The mysteriously strong euro of the first half is partly explained by the fact emerging-market central banks accumulated reserves at a monthly rate of about $70 billion and converted about $25 billion of these into euros, estimates Nomura.
That slowed sharply in August, by perhaps 60% or so, and has ground to a halt in September.
"In the aggregate, there may be no [reserves] accumulation at all, suggesting no euro buying and a swing of about $25 billion, from normal pace," said Jens Nordvig, Nomura's head of major currencies strategy.
"This is a huge change relative to the situation in January-July, and has been an important component in allowing the euro to decline in August-September," he said.
Both Messrs. Nordvig and Stannard are targeting a move in the euro to $1.30 versus the dollar by year-end, but are now wary of the currency's growing downward potential as a result of the euro zone's slowing economic growth and unresolved debt tensions.
Recent central bank action, if it marks the start of a new trend, is further reason to be bearish on the single currency.
"Things are unfolding as we pretty much expected but as the risk starts to build on the downside, even our bearish forecast could be overtaken by events," said Mr. Stannard.
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