The Morning Commentary: Are Central Bank U.S. Dollar Sales Structural or Tactical?
A daily summary and commentary of events and factors that affect the global markets, with a particular emphasis on the foreign exchange markets.
Are Central Bank U.S. Dollar Sales Structural or Tactical?
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Andrew Kositkun Foreign Exchange Head Trader
Global central banks are a naturally important can closely watched group of investors for several reasons, including their $12.3 trillion investment pool. Over the past six months, a notable market hypothesis has been the possibility that central banks could be contributing to U.S. dollar (USD) supply and euro (EUR) demand, thus supporting the EUR/USD uptrend. As a result, third-quarter IMF COFER data released in late December has become important to benchmark whether or not there is structural diversification out of the USD.
Data from this release shows that central banks continue to rebalance their portfolios in response to price movements. Put another way, central banks actively bought $60 billion worth of USD and sold $6 billion worth of EUR to partly offset the impact of USD depreciation on their portfolio compositions. Over the past year, central banks, on net, have bought $208 billion worth of USD and have sold $23 billion worth of EUR.
Overall, these numbers do not really suggest an individual, let alone collective, loss of confidence among central banks in the USD’s place as the dominant reserve currency. So while COFER data doesn’t necessarily support the narrative that central banks are structurally diversifying away from the USD, it doesn’t invalidate the theory that central banks, especially those in Asia, are selling dollars in recent months as a result of efforts to recycle increasingly large volumes of local FX intervention. To this point, recent data shows Asian central banks have leaned against the USD downtrend by engaging in the fastest pace of intervention since late 2013 to early 2014.
Essentially, the takeaway from the data is that central bank activity tends to reinforce the prevailing dollar trend. Should the USD as a whole start to steady as a result of stronger domestic growth and higher yields, the pace of necessary intervention should slow and thus lead to a pullback in recycling inflows into the EUR.
HERE ARE THE KEY NEWS STORIES FROM OVERNIGHT:
The House of Representatives is set to vote on impeaching President Donald Trump today after Vice President Mike Pence refused to use the 25th Amendment. A dozen or more Republicans, including No. 3 House Republican Liz Cheney, are expected to support impeachment. As for the Senate, it has been reported that Republican Senate Majority Leader Mitch McConnell is happy about impeachment developments. Assuming President Trump is impeached, the Senate is on recess until the day before President-elect Joe Biden’s inauguration, making it unclear whether or not there will be a trial while Trump is still in office.
Joe Biden is expected to seek additional COVID-19 aid with Republicans instead of pushing through a package without Republican support. This would likely mean a smaller initial package with priorities favored by the Republicans.
U.S. CPI rose 0.4% month over month, meeting expectations, and rose 1.4% year-over-year, beating expectations for a 1.3% increase.
Several Fed speakers have pushed back on the notion of tapering anytime soon. Fed officials Esther George and James Bullard both indicated yesterday that it was too soon to speculate about the timing of any change in the Fed’s stance.
Italian political noise continues, with former prime minister and current Italia Viva leader Matteo Renzi holding a press conference today to discuss the possibility of pulling his ministers from the ruling coalition. In the end, this is likely just posturing in an attempt to squeeze out more concessions given recent poor polling data for Italia Viva that indicates a loss of seats should new elections be held.
On the virus front, the U.K. and German governments are considering more COVID-19 restrictions. In Japan, the government extended the state of emergency to seven more prefectures, bringing the total number up to 11. Nearly 60% of the country’s GDP is now under lockdown.
Chinese officials could be growing uneasy about yuan strength, as the central bank set its weakest daily fix, relative to market modeling, since mid-2018. This comes after several small measures to encourage capital outflows and limit capital inflows.
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