Last week we reported on a note from Citi FX strategist Steven Englander, who predicted that central bank reserve managers would begin dumping dollars in the coming weeks, based on a key set of criteria.
Today he confirms that the criteria have been met:
Last week we published our analysis of reserve manager behaviour and presented a trading rule based on the following conditions:
1) The USD fell in the prior calendar month;
2) The (currency valuation adjusted) increase in reserves in our subset of reserve managers is positive; and
3) Higher than in the previous month.
Our subset of reserve managers consists of a sample of reserve managers who report reserves soon after month end. We adjust nominal reserve accumulation to remove currency valuation effects. For proprietary reasons, we do not disclose the reserve managers in our subset (all data is publicly available on Bloomberg) and we only use the subset aggregate in our analysis.
If conditions 1 through 3 are met, the rule says buy EUR/USD on the seventh business day of the month (by which time the early reporting central banks in our sample will have reported their reserve levels), and hold the short USD position through the seventh day of the next month.
These conditions were met in November with valuation adjusted reserves in our sub-sample growing by 1%, and the dollar having dropped sharply in October.
The intuition is that we think that reserve managers are a latent USD selling force because of the size of their portfolios and concentrated holdings of USD. The immediate response is likely to be aggressive efforts to avoid being left holding an ever expanding USD bag.
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