Wanna know why EUR/USD is at record highs?

Wednesday, July 11, 2007

1) FX reserve growth continues at a ridiculous pace. China released its Q2 reserve data today, and Jon Anderson of UBS was right- reserve growth did slow in Q2. Instead of growing $135 billion, as it did in Q1, China's pile of FX reserves grew by a miniscule $130 billion in Q2. The chart below illustrates the reserve growth of China, India, Russia, and Taiwan.
2) The pace of growth really has been parabolic. Consider the rates of change of China, Inida, and especially Russia over the last year. All of these countries are active particpants in diversifying/maintaining portfolio benchmarks for their currency reserves.

3) Adjusting for valuation, the TRIC central banks (RIC, really, since CBC has actually sold a few dollars recently) had to buy €39 billion in Q2 just to maintain portfolio benchmarks. When one considers that Russia's reserve growth is almost certainly mirrored in the Gulf, and that some Gulf states have much lower dollar weightings in the their portfolios than China or even Russia, the official demand for euros in Q2 could easily have exceeded €50 billion.

It looks like the CBs and investment authorities were hoping to buy euros on the dip, but failed- hence the recent scramble to pay offers at nosebleed levels. Looks like they've been using a ratings agency toolkit of their own!

Posted by Macro Man at 1:02 PM  


parabolic indeed. in the words of inspector gadget, yowsers. free markets my ... i guess fx moves really just depend on the pace of reserve accumulation and the resulting benchmark reallocation. what a mess...

tm said...
1:31 PM  

sorry, that was me.

tmcgee said...
1:34 PM  

Ha, yes I assumed it was you. Welcome back, by the way.

Macro Man said...
1:41 PM  

Macroman, I'm impressed with your charts. Where do you get the data for the central banks holdings? from each bank individually? How can you tell that the amount they need to buy of Euros as a specific amount? Is it just to maintain the fraction they already have as the total grows? In that case have you done the same for the dollar? and isn't even bigger?
Bud Conrad

Bud said...
3:19 PM  

I get the data from Bloomberg and assume an asset allocation benchmark which I think corresponds broadly with reality (anecdotal evidence, IMF data, Brad Setser's work, announced benchmarks) which is basically 70% $ and 30% € (a small simplification.)

From there I just 'grow' each reserve bucket in time T by exchange rate moves and interest rate carry to time T + 1, compare those totals with the new reserve totals released by the CBs, and calculate how many EUR they need to buy (or, in the old days, occasionally sell) to get back in line with benchmark.

Macro Man said...
3:34 PM  

This whole system is a disaster waiting to happen. It can only be continued through massive massive imbalances. That is scary and dangerous. I think Im going to out and buy a farm.

James said...
4:35 PM  

Thanks for your explation.

The 30% Euro 70% ratio of reserves seems right in total, and could be less dollars in the immediate addition if CBs want to rebalance. My comment is that they are still accumulating dollars too, and at maybe a faster rate so this may not be the only important driver of the exchange rate move against the dollar. The problem occurrs when they don't want to take on any more dollars and all rush for the exit, and the question is to what? The other currencies are about as bad, and there isn't enough gold. That leaves setting up investment management groups to buy equities or strategic resource reserves, which is what they are getting around to. Even buyinig companies outright with dollars, begs the question of what the people that get the dollars for selling the company then do with those dollars. My view is that they buy other companies thus inflating the stock markets of the world.

Great charts!

Bud said...
10:25 PM  

Yea, but Tim who finances the US CA then? All these stupid governments can go hunt for better yields, but then who wants treasuries at 5.15 percent. Setser says no one in the private sector. There trapped and this system is on a very unstable path. I hope everyone learns there lesson. Governments should not be going into the capital markets! The private sector is the only efficient allocator of resources!

James said...
10:57 PM  

tell that to henry blodget...

Anonymous said...
11:15 PM  

Bud, between buybacks, private equity, and sovereign wealth funds, from a medium-term perspective this is an incredibly bullish environment for equities. Less so for fixed income and credit in particular, as the above phenomena simultaneously imply increased supply and reduced demand.

The whole subprime/CDO fiasco also calls into question the efficiency of private sector agents to allocate resources; that's not to say that the private sector is not more efficient than the public sector, of course- generally speaking, I believe that they are for non-public goods.

As such, I would argue that the appropriate role for public sector agents in trade and markets is primarily a regulatory one rather than a participatory one, at least when it comes to non-domestic markets.

Macro Man said...
10:35 AM  

Thanks for article!

BuyLevitra said...
12:56 AM  

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