“The USD buying has intensified ahead of the December Fed meeting. Expectations of USD appreciation supports demand from both global investors and corporates, with the former trying to buy the currency to meet the payments on their sizeable USD-denominated debt.
Some EM central banks appear to respond to the growing demand for USD by selling FX reserves. Recent history further suggests that the drop in FX reserves was usually accompanied by weakness in majors like EUR, implying that the central banks sold liquid G10 holdings and converted the proceeds into USD to meet the FX demand at home.
This turns into a powerful virtuous cycle for the USD that broadens and strengthens its recent uptrend. It can explain the latest EUR/USD selloff that is seemingly at odds with currency fundamentals like rate spreads and sovereign bond yield spreads.
Recent history could suggest that the EUR-undervaluation may persist so long as global demand for USD continues to erode central bank FX reserves and forces them to liquidate assets in liquid USD-proxies”.
Copyright © 2016 Credit Agricole CIB, eFXnews™
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