Toxic Dollar: Why Nobody Seems to Want US Currency

Traders are warning of a dramatic change in dollar selling. They fear central banks from the Middle East may force their Asian rivals to more aggressively drive the dollar down.

Too Many Dollars

In 10 months, the Dollar Index has lost 14% because the world keeps accumulating dollars it doesn’t want and sells them. Asian central banks are key.

Gaetan Charbonneau | Getty Imags

Many Asian central banks have been forced into waging wars to keep their currencies from appreciating because of the influx of investors to emerging markets. They sell waves of their own currencies into the market in an attempt to keep exports competitive.

In return they often receive dollars. But with the Federal Reserve printing dollars and the greenback’s value continually falling, the Asians sell those dollars in order to preserve the value of their reserves.

“Asia Pacific banks are renowned for their strict diversification” says Neil Mellor at BNY Mellon. “They hold a level with China in order to be competitive. Beyond that it’s very strict ratios. They need to swap-out of dollars.”

Euro Benefits

When they sell dollars they often buy euros.

“China and Taiwan have tried looking further afield in their diversification, to the Australian and South Korean bond markets” says Mellyor. “But there are only two places that are deep enough to absorb reserves of this magnitude: the Euro Zone and the US. When ever you see emerging markets perform well you will see the euro perform well.”

Three months ago central banks in Latin American joined the Asians as “currency wars” became more widespread.

Euro/Dollaris now up 19% in 10 months. In fact there’s a growing realization that the ascent of the euro more to do with Asian bank diversification than anything happening within the Euro Zone.

“Euro/Dollar is trading without reference to the underlying debt markets” says Mellor. “In fact it’s our contention at BNY Mellon that the entire move in the Euro since 2001 have been driven by the Asian central banks need to diversify.”

Importantly however some believe the banks have deliberately sought to control the speed of the dollar’s decline by passively working bids to simply add liquidity on existing moves.

“They have been working bids below the market, relying on the market to come to them, as Europe’s sovereign debt fears and interest rate differentials trigger bouts of temporary dollar strength,” says Douglas Borthwick at Faros Trading.

But Borthwick says the Asians may be forced to abandon that because of fresh, aggressive dollar selling from the Middle East.

Middle East

US crude prices have risen 30 percent since Libya’s “Day of Rage” Feb. 14 above $100 a barrel. The International Energy Agency says OPEC nations will net one trillion dollars a year. The political tension also demands petrodollars are sold and the proceeds increasingly repatriated, as Saudi King Abdullah’s $93bn-worth of handouts demonstrate.

“The Middle Eastern players seem to be willing to chasing the market higher,” says Borthwick. “When the EUR/USD rallies 30 pips on air you can be assured this is a Middle Eastern reserve manager diversifying out of Dollars they have received from the higher price of oil.”

If the Arabs keeps “front running” their orders the Asians may be forced to abandon their passive approach and raise their euro/dollar bids.

“If Asian central banks are passive, they miss buying the EUR/USD at 1.4040,” says Borthwick. “Through frustration the they are moving from set bids to rolling bids...i.e. set a bid 50 pips below today's high.”

Analysts say that would prove even more toxic for the dollar.

“Euro/dollar is massively overvalued but we keep calling the top and it doesn’t work,” says Paul Bednarczyk at 4-Cast. “We could top out at 1.50. And then wait to see what the Fed does with QE.”

Correction: US crude prices have risen 30 percent since Feb. 14. An earlier version of this article incorrectly had them rising 54 percent.