Earlier this week, Adam reported that China (via the institution that manages its foreign exchange reserves) was at least partially responsible for the Euro rally. If/when China desire to swap Dollars for Euros has been sated, the Euro rally could theoretically lose steam. At this point, it’s too early to call the end of the rally, since its steady appreciation has been marked by a handful of short-lived corrections. However, if this is indeed the start of a U-Turn, hindsight might show that it was inevitable that it would occur at this level.
As an aside, the kinds of back-and-forth
swings that have become commonplace in forex markets may be
attributable to large-scale investors, such as Central Banks. As
currencies (or other securities, for that matter) decline, investors
will often take advantage of low prices and enter the market. When
prices rise, these same investors (joined by long-term investors) will
often take profits and sell. As a result, it is hard for currencies
to rally continuously without any kind of correction.
Back to the Euro, there are a handful of
Central Banks who are making their presence known on this front. On
several occasions over the last few weeks, the Central Bank of Switzerland (SNB) has unloaded
massive quantities of Euros. If you recall, the SNB amassed nearly €200
Billion over the previous year, as part of a massive buying spree aimed
at holding down the value of the Franc. Given that the Franc has
appreciated by more than 15% against the Franc this year, it’s perhaps
unsurprising that the SNB is throwing in the towel. (Oddly, it waited
until Euros were cheap before it started selling).
Analysts from Morgan Stanley
foresees a similar trend: “Central banks are likely to let their euro
holdings slide as a percentage of the total, reflecting lingering
concerns about the euro zone’s fiscal outlook…’We do not expect that
central banks will provide as much support for euros as in the past.
They have prevented the euro from depreciating more rapidly… but they
are unlikely to stop its depreciation.’ ” The implication is clear: the
Euro is facing (passive) pressure on multiple fronts.
In fact, the kinds of back-and-forth swings
that have become commonplace in forex markets may be attributable to
large-scale investors, such as Central Banks. As currencies (or other
securities, for that matter) decline, investors will often take
advantage of low prices and enter the market. When prices rise, these
same investors (joined by long-term investors) will often take profits
and sell. As a result, it is hard for currencies to rally continuously
without any kind of correction.
While it’s true that the average daily turnover of the global forex markets now exceeds $4 Trillion,
the majority of this represents the rapid opening and closing of
positions by the same group of traders. Only a small portion of this
actually represents meaningful changes in portfolio allocation. Thus,
when the SNB or the Central Bank of China buys or sells €15 Billion, it
can seriously alter the course of the Euro, even though it would seem to
represent an insubstantial portion of trading volume. Thus, market
participants (especially amateurs) are advised to watch these market
movers for signs of changes in their respective portfolios, because they
will often signal the direction of the market.
For example, from 2002 to 2009, “The euro’s
weighting in global reserves rose to 28% from 23%, according to
International Monetary Fund data,” and over the same time period, the
Euro rose 50% against the US Dollar. It’s possible that the Euro’s
appreciation drove Central Bank purchases of the Euro, rather than the
other way around. The truth is probably that the two trends reinforced
each other. Given that Central Bank reserves are once again rising, any
changes in portfolio allocation could have significant implications for
the forex markets.
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