Why Hasn't the Euro Tanked? (Part 2)

(…Continued from Part 1)

It goes without saying that the Euro has underperformed since the inception of the crisis in Europe. Yet faced with the possible extinction of the currency itself, many have called for an even lower rate in the Euro-US Dollar cross. Adding on to Part 1, detailed below are several more possible reasons why the rate has yet to sink even lower.

For those countries fortunate enough to hold significant foreign exchange reserves, their second most popular currency of choice after the US dollar is still the euro. Although the fraction has fallen, it’s estimated that nearly a quarter of all reserves are still held in euros. If these countries are seeking to maintain a fixed percentage of each currency in their reserves, then after the euro falls against the dollar, they will need to rebalance to this percentage by purchasing more euros.

Another phenomenon that may be acting to support the euro has been repatriation of proceeds from asset sales of European banks. In anticipation of risk events (and in response to increased regulations) European banks have been forced to raise euros. This enables them to protect themselves from a possible freeze-up in short term lending markets and shrink their balance sheets. In order to create this cushion, it’s argued that they’ve sold many USD based assets, and repatriated the proceeds into euros.

One of the more obvious buyers of euros has been the Swiss National Bank. In order to maintain the franc’s peg to the euro at 1.20, the central bank has been forced to buy euros and sell francs. Although they sometimes "recycle" their purchases to offload some exposure (by selling euros vs. other currencies including the dollar), the overall percentage of their reserves denominated in euros has increased.

Another suspected group of euro buyers has been foreign investors. With depressed valuations of the currency as well as individual companies, acquisitions and investments in European firms by foreign ones are beginning to pick up. China alone is reputed to account for a large proportion of these purchases.

In summary, although the euro’s value has certainly fallen, we’ve yet to breach the Euro-Dollar low from 2009. Some had predicted dollar parity by now, but for various reasons (including those above) the euro has continued to hang on, at least against the dollar. Whether the euro will ultimately survive, I would argue, is more of a political decision. But these factors should continue to affect the price action of the Euro-US Dollar cross until that decision is made.