As the Euro continues to languish among the lower ranks of the major currencies and the European Union’s economy continues to flounder, banks keen to steer clear of negative-yielding assets in a rapidly depreciating currency could cut the foreign exchange (FX) reserves they hold in the European single currency by upwards of $100 billion according to analysts.
The Euro’s poor performance which began almost one year ago and culminated in the lowest value since inception just a month ago, has resulted in drastic action by certain central banks, including Switzerland’s removal of its peg between the Franc and the Euro which sent markets into a period of unprecedented volatility, with more likely to follow.
Measures such as those taken on January 15, which protected the interest of the Swiss National Bank, are not conducted lightly, and six years on from the global financial crisis, Europe is still three times over its GDP in external debt, has up to 57% youth unemployment in certain member states, and rather than rebuilding industry and turning its situation around, has been reliant on several bailouts which range from the nationalization of failing banks to entire member states receiving funding to stave off national bankruptcy.
The Euro’s low values and economic factors which surround such depreciation, combined with the move below zero of many euro-zone government bond yields have driven a shift by official institutions, among the world’s most conservative investors, in how they manage their $11.6 trillion of FX reserves.
Several analysts, mostly in conjunction with bearish forecasts on the euro, said they expect central banks’ euro-denominated reserves to fall from around 22 per cent to below 20 per cent of overall holdings over the coming quarters.
A continued decline in the euro’s value against the US dollar will account for much of that, but outright selling could still run into a 12-figure sum – a significant flow out of the single currency and a major force for further weakness. Whereas Europe’s economic situation is still reliant on bailouts and extremely resource-hungry quantitative easing measures, the United States, which also was the subject of a credit crunch in 2008 and 2009, has re-established itself economically and its industry is flourishing.
“This shift could amount to as much as US$104 billion per year,” according to estimates from Goldman Sachs.
The latest International Monetary Fund data shows that global FX reserves fell by 3.1 per cent, or $383 billion, in the second half of last year to $11.6 trillion.
Around two-thirds of that was due to valuation effects from the euro’s 11.7 per cent fall in that period, according to JP Morgan. The euro’s share of all reserves fell to 22.2 per cent, the lowest since 2002.
Stephen Jen, manager of SLJ Macro hedge fund in London, explained to Singaporean news source AsiaOne that will fall by a further 2-4 percentage points in the coming quarters, equating to a reduction of about US$240 billion to US$480 billion.
EURUSD chart courtesy of Google Finance.