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The Biggest 10-Year Trend In Currency Markets Has Come To An End

Simone Foxman

Arguably the prime driver in foreign exchange markets for the last ten years, unsterilized intervention by emerging market central banks in the currency markets has had a positive impact on the value of the euro against the dollar.

According to  Greg Anderson, Citi's chief of G10 FX Strategy in North America, that trend is gone, and it "is unlikely to return anytime soon." He told Business Insider that only a "surge of global growth and optimism" is likely to create new demand for the euro against the dollar, and in the best case scenario it would still take months if not years to re-emerge.

For years, emerging market central banks have been intervening in foreign exchange markets to keep the value of their currencies from appreciating too quickly. Central banks in the BRIC nations, Saudi Arabia, South Korea, and Mexico have been purchasing large sums of U.S. dollars to expand their monetary base.

While those sums were mostly reinvested in Treasury bonds, these banks would also "recycle" many of those dollars.

Anderson writes in a note today (emphasis added):

As EM central banks purchase USD, they have tended to recycle 25-50% of the proceeds out in to EUR in relatively short order. This has created steady EURUSD demand, except during the crisis period from August 2008 through March 2009, when EM central banks briefly sold EUR as they spent reserves to defend their currencies. Now that source of EURUSD demand is gone. Although we won’t have the data for months (China won’t release April and May reserves data until July), it is likely that central banks have also been spending reserves and selling EURUSD in April and May...

The key point to take away is that official EURUSD demand is gone and unlikely to return any time soon. Without what has arguably been the biggest factor driving EURUSD upward movement over the past ten years, downside pressures are much more likely to prevail.

Emerging market demand for euros—likely one of the major factors keeping the value of the euro at $1.30-$1.35 from January to May—has now leveled off. Anderson points to the chart at right to show that growth in EM FX reserves has vanished.

In a phone interview, Anderson told us that only a transformation in global growth would reinstate the trend.

"[We would need] a surge of global growth and optimism about equities in particular, which would cause a big wall of money to go buy emerging market equities again. And that would start a new phase," he said in a phone interview Wednesday.

He noted that there could be a brief return to reserve accumulation. "Y ou might have a little burst of it if we saw positive news out of Europe," Anderson said.

But even that would be short-lived. " As a steady trend, it would probably take 6 months at least to reemerge."

So much for the euro, folks.

UPDATE: ForexLive's Jamie Coleman reported two weeks ago that the central banks mentioned above might actually be taking the reversal in this trend further, in fact selling euros they are holding in reserve when their value rallies.

If this is the case, then that will only compound downward pressure on the euro.

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