Despite investors still carefully watching the rally of US stock markets as we begin the third quarter earning season; attention is also being drawn towards the prospects of the US dollar which has fallen over 10% in value on a trade weighted basis during the past six months. This is the biggest fall in the greenback since 1991 and the negative sentiment surrounding the currency is reminding many currency analysts of a similar time in the mid-1990’s when the debate over diversification was a central point for FX strategy.
Barclays, last week, released an interesting report highlighting that central banks over the past two quarters have stepped up their diversification of foreign currency holdings away from the US dollar. The report noted that 63% of new cash has been placed into euro’s and yen in April, May and June. Thus, the fall of the dollar’s participation to 37% of new reserves compares unfavourably to its 63% average since 1999.
FX analysts are focusing on two aspects of the diversification away from the US dollar; the first being the concentration risk and secondly return. The concentration risk of central bank holdings of the greenback has been and will continue to be a long term structural trend. Indeed, it was also a major talking point back in the 1990’s and this shift of diversification by central banks was even being implemented back then. The significant difference between the 1990’s and now is the power of China regarding US currency reserves. China does not release its data on its allocation but it would be difficult to believe, given the shift by other central banks that they have not participated in some form diversification. However, this concentration risk can be considered a background trend that could curtail the strength of the US dollar in any ultimate rally but should not be viewed as the isolated reason to sell the US dollar. Given their holdings it is not in the interest of central banks to see the US dollar collapse.
The secondary factor at play at the moment is returns. The world is swamped with US dollars which are currently producing little return, thus there is little incentive to increase exposure towards this assets. It was interesting to note Friday’s rally in the US dollar, following on from Bernanake comments on Thursday. No doubt when the Federal Reserve does start to raise interest rates then the appeal of the US dollar will start to alter. The outcome from the 1990’s also reminds analysts that betting longer-term against the US dollar is dangerous; after its sharp falls in 1990’s the greenback rallied back over 25% against the deutsche mark during the next two years.
Today, there is little data out of note and with Japanese markets closed today and Columbus day in the US activity is expected to be very quiet. As such, the usual Monday round up of pending economic data will happen in tomorrow’s no doubt smaller Daily.
Sources: Reuters: BBC: Bloomberg: Lawshare: Deutsche Bank (db): Proquote: Financial Times: Wall Street Journal: CLSA: Sharescope: Market News. Capital Economics: CNBC: Wikipedia:
Please note this report provides a guide to some of the relevant areas that individual investors should consider discussing with an authorised adviser in relation to their specific circumstances, it does not constitute individual advice. As a result no action should be taken or refrained from being taken as a result of its content.
