A recent piece by Barclay's Steven Englander demonstrates how everybody and the kitchen sink is soundly amused by Geithner's call for a strong dollar. "The IMF Composition of Official Foreign Exchange Reserves data suggest that central banks are doing more than talking about reducing the concentration of USD in their reserve portfolios. They are actually acting on their statements." This should come as no surprise to anyone following the Fed's central bank liquidity swaps which have plummeted to post-(and pre-) Lehman lows, as the Fed no longer needs to bail out its counterparts' short dollar positions.
Some highlights from Englander's report:
- Q2 09 was the only time that central banks have accumulated more than USD100bn of reserves in a quarter, and the USD’s share of this accumulation has been less than 40%.
- This is also the only time the EUR has accounted for more than 50% of the accumulation when central banks, in aggregate, have accumulated more than USD80bn.
- The JPY’s share of the increase in reserves was 12%, by far the highest incremental JPY share since 2005.
- The drop in aggregate reserves in Q4 08 and Q1 09 was almost all USD, but the recovery has been primarily in non-USD reserves.
How does this manifest itself graphically?
Figure 1 shows just how unprecedented it is for central bank reserves accumulation to be concentrated in non-USD currencies. Since 2006, in quarters when the central banks have been accumulating reserves, the USD has represented almost 70% of this accumulation on average, so Q2's 37% amounts to a big step down.
Since the global recovery got underway at the beginning of Q2, the USD has been among the weakest of the major currencies. By definition this means that the US current account funding needs, while lower, were not reduced enough to stabilize the dollar. Other data, in particular the US Treasury TIC data, show unambiguously that there has been an outflow of capital from the US. The US private sector has been buying USD30-40bn of foreign portfolio assets, effectively doubling the financing need implied by the US trade deficit. The foreign private sector has been selling US Treasury obligations.
The last sentence also is no surprise, because as pointed out on Zero Hedge first, the Fed now accounts for the majority of Treasury buying, in essence leading to a feedback loop whereby its primary goal is to lead to dollar destabilization.
As for the key ongoing divergence between the dollar and the euro, Barclays provides this observation:
To be blunt, this is little more than saying there were more sellers than buyers of USDs, and more buyers than sellers of high quality EM currencies at the exchange rate levels that prevailed at the beginning of the recovery. However, it helps address the issue of how we know that the global private sector was not selling EUR and other European currencies in order to buy EM assets. The reserve accumulation data show as much buying of the EUR as the USD, so why view one as being bought and the other as being sold? The difference is that the EUR has appreciated while the USD has depreciated over this period. This suggests that EM central bank buying of the EUR (in addition to whatever the private sector was doing) was sufficient to firm up the EUR, while USD purchases by EM central banks were not enough to keep the USD from falling.
And another red flag for Fed apologists, whose actions have been crucial in enforcing the weak dollar doctrine:
Our conjecture is that first, EM central banks acquired USD through intervention and then sold USD them versus the EUR and other currencies as a way of preventing their portfolios from becoming to top heavy in depreciating USDs. Historically, we have observed that the accumulation of non-USD and USD reserves occurs in parallel. (Figure 1 shows this as well.) We have also found that the central bank accumulation of reserves is strongly associated with USD weakness. So there is some reasonably strong circumstantial evidence that USD weakness within G10 is associated with central banks building reserves, which supports our conjecture above, that the dynamic is driven by the USD overhang rather than some exogenous demand for EUR reserves by central banks.
The conclusion from Barclays is startling, mostly due to its analysis of implications to the Eurozone (obviously negative) and that the JPY, despite its low yield, will likely become less of a carry trade focus in the years to come. This speaks volumes about how the rest of the world sees the American economy, even after Japan's two lost decades. What the future has in store for America apparently can not even compare with the Japanese experiment.
No one wants to be caught holding too many dollars, and this rising reluctance is increasing pressure on the USD. This is an obvious USD negative, but it is also means that the ECB and the EUR are caught between a rock and a hard place. The capital flows into the EUR have very little to do with any euro area cyclical dynamism. If the ECB were the BoC, it would label the current EUR appreciation as undesirable “type 2” flows driven by capital flows that do not reflect fundamentals. However, as anyone who has been to the doctor knows, getting a diagnosis is not quite the same as being cured.
One surprise to us is some renewed JPY accumulation in reserve portfolios after years of decumulation. Given the USD overhang, the zero-yield JPY may be more attractive than the zero-yield USD, even with all the negatives surrounding the Japanese economy and its prospects.
The last and more tentative takeaway is that claims in other currencies (non EUR, USD, GBP, JPY or CHF) rose more than 10% in Q2. It is hard to tell what currencies in this category represent and how much of the gain is due to valuation effects. However, it could be that some of the smaller G10 currencies are beginning to get a “look see” from reserve managers.
As equity markets now follow the DXY tick for tick, which in turn follows the actions of Ben Bernanke to the dot, it reinforces our thesis that at this time, investment decisions can be completely removed from corporate income statements, balance sheets, and most troubling, cash flow statements (as unfortunately there is little to none positive cash flow to even talk about) and the only focus is on such excess liquidity aggregator representations as the Z.1, the H.3 and the H.4.1. As for what is happening at that other bubble spewing economy, China, at this point it is really anyone's guess as to what is going on there.