Has Voldemort Fallen Out of Love With the Euro?

Macro Man is still struggling to pick his jaw up off the floor this morning, still attempting to come to grips with what he saw over the long bank holiday weekend. You see, for the first time since John Major was PM, the UK enjoyed a sunny and warm May bank holiday weekend. Not that such beautiful weather is without demerits, however; not only did Macro Man get stick from Mrs. Macro for allowing Macro Boy the elder to get sunburned playing football sans shirt yesterday, but he'll now have the memory of last weekend thrown in his face when he dares complain about UK weather when it's 55 degrees and rainy on the 4th of July. Ah, the crosses we must bear...

In any event, recent price action in currencies has been instructive. The dollar has tried to sell off this week, led in part by record high oil prices and a rebound in gold that will no doubt delight the tin-foil hat brigade. However, the euro rally above 1.55 has been met by reported sales from Asian central banks, a theme that's been ongoing for the last week or two. Now, what's peculiar is that the euro was essentially frog-marched up to 1.60 by central bank demand....but since then has been sold off aggressively, with some of the same names that had previously been buying cited as the sellers. This has led Macro Man and others to speculate: has Voldemort (and others) fallen out of love with the euro?

What's beyond dispute is that something has changed chez Voldy. Having allowed the RMB to appreciate at a record pace earlier in the year, the rate of change in USD/RMB has slowed to a standstill, touching a zero rate of change over one month for the first time since late summer. While some of this could perhaps be attributed to a higher import bill/lower trade surplus and short covering, it seems highly likely indeed that SAFE has been buying dollars in their usual egregious volumes to slam the brakes on RMB appreciation. (Why they should want to do so is another question altogether; Macro Man would put it down to wanting to screw speculators as well as a misguided attempt to defend exports.)

Regardless of the reason, it's clear that FX reserve manager assets are continuing to rise at a nearly parabolic pace. The BRICs alone managed to add $242 billion to their reserve assets in Q1 alone. Now, what's interesting is that a lot of that can be explained by the sharp increase in the dollar value of non-dollar reserve assets; or, put another way, despite the marked increase in reserves, Macro Man calculates that Voldemort and co. had relatively little EUR/USD to buy to maintain portfolio benchmarks. Indeed, Macro Man's model put the required quarterly EUR/USD purchases at their lowest level since Q3 2004.

And yet, anecdotal evidence suggests that FX reserve managers were highly active in the FX market buying euros in the first three and a half months of the year. What's going on here? Macro Man can come up with a few possible explanations:

1) After their early April buying spree in EUR/USD, Voldy and co. found themselves overweight euros at 1.60, put on their value hats, and said "oh sh**. Sell, Mortimer sell!"

2) French Finance Minister Christine Lagarde got SAFE on the dog and bone and gave them the same "hairdryer treatment" she treated the G7 to. To avoid more of the same, they've agreed to let EUR/USD come a bit lower for a few weeks until she's found something else to complain about (ECB rates, anyone?)

3) Perhaps...just perhaps...they've realized that in walking EUR/USD higher, they have helped drive food and energy prices higher via the invoice currency effect, and that they are shooting themselves in the foot by generating social unrest (via food and energy inflation) through their FX market activities?

On second thought, maybe none of these is the case. Maybe they're just selling euros because they're ****s.

Comments

[MartinLowenthal]

I have been talking about the Euro and Europe's mess for ages. Dollar will strengthen over time as Western Europe has big problems to deal with. www.lompie.blogspot.co...

[Coelacanth]

First things first......what's up with two English teams in the final for Champions League? Kind of a drag. Either way, I think Man U. will pound Chelsea. They seem unstoppable this year and I don't like Chelsea. LOL.

They're selling euros because the cracks are starting to show in the euro-zone. Especially retail sales, consumer & business sentiment which have been atrocious the past couple months. Tonight's April euro-zone retail number should be interesting and I expect it to fall way below consensus again. Although the final PMI reads came in a little stronger than the earlier flash estimates.....it's pretty clear Europe won't be immune from the effects of a U.S. recession (yes, I said "R" word).

I have slightly less contempt for Trichet than I do the befuddled looking Mervyn King because at least Trichet will have the cojones to stand up to Sarkozy & Burlesconi (can't believe the Italians re-elected that guy) as they become more vocal about monetary policy in the face of worsening economies.

That said, I do grow weary of listening to Trichet drone on and on about "price stability". In case you haven't noticed Mr. Trichet, the slow burn of lenders not lending has a nasty recoil.

[dlaw]

I can't comment on Voldemort (which is who exactly?) but I think this talk of euro's demise is very premature indeed. This little dollar pullback stinks of excessive anti-euro sentiment among traders, in my view.

I don't have much money on it, but I would not be surprised at all to see eur/usd to go through $1.60 with a bullet.