A year ago the talk of the town was how governments would abandon the US dollar in favor of Euros and this would be the death of the dollar. At that time China denied speculation it was diversifying out of the dollar. Look at how things change.

Now China denies speculation is it diversifying out of Euros. Please consider China Euro Policy Denial Prompts Detection of Changes.

The euro weakened 2.4 percent against the dollar last week even after China’s State Administration of Foreign Exchange, which manages the country’s $2.4 trillion of reserves, denied speculation that it was diversifying away from European bonds. The 20 percent depreciation from last year’s peak in November has demonstrated the limits of the euro as a reserve currency to rival the dollar as well as the European Central Bank’s ability to defend its legal tender.

A net 105 billion euros ($129 billion) flowed out of the region’s fixed-income markets on an annualized basis in the first three months of the year, signaling a “broad shift” in appetite for euro-denominated assets, according to Nomura Holdings Inc. The region attracted a net 225 billion euros from foreign debt investors in 2009.

“It’s clearly the case that there’s been an element of foreign central banks slowing down their euro purchases,” said Jens Nordvig, a managing director for foreign-exchange research at Nomura in New York. “The institutional framework is being questioned, the credibility of the ECB is being questioned, and all that uncertainty is really fueling an asset allocation shift away from the euro zone.”

“There’s a growing realization that the outlook for the currency is bleak,” said Samarjit Shankar, a managing director for the foreign exchange group in Boston at BNY Mellon. “There is evidence that central bankers and reserve managers are trying to diversify away from euro.”

“Both the dollar and the euro have structural debt problems but at least Europe is doing something about it,” said David Bloom, global head of currency strategy at HSBC Holdings Plc in London. “The pendulum will swing against the dollar later this year as people realize that the U.S. has even bigger problems than the E.U.”

HSBC predicts the euro will end the year at $1.35 as the U.S. mid-term elections in November shift attention to the nation’s inability to reduce a deficit projected to reach $1.5 trillion this year.

The number of wagers by hedge funds and other large speculators on a decline in the euro stood at 106,736 contracts more than those anticipating a gain on May 25, near the record 113,890 on May 11, according to data from the Washington-based Commodity Futures Trading Commission. As recently as December, bullish contracts exceed bearish ones by 22,151.

“The move lower in the euro is not just speculation,” said Lee Hardman, a currency strategist at Bank of Tokyo Mitsubishi UFJ Ltd. in London. “There has been an asset allocation away from euro. The problem is deeply rooted and fundamental in terms of unsustainable fiscal deficits.”

Crude Priced in Euros

Flashback October 06, 2009: Anyone remember the Ridiculous Hype Over Secret Oil Meetings that oil priced in Euros would kill the dollar?

It made no more sense then than it does now, which is to say “none”.

What matters (as we have clearly seen) is willingness to hold a currency, not a pricing unit on oil or anything else.

Euro Weekly Chart

click on chart for sharper image

This morning the Euro printed a fresh new low below 1.2120 before bouncing.

Euro 30 Minute Chart

There are now so many Euro bears, a bounce is quite possible.

One of the reasons I liked the US$ index at 75 was sentiment on the dollar was so bearish. Now the opposite is true.

However, It is important to realize that crashes do not occur in overbought conditions, but rather oversold ones. It will not be a good sign if the ECB decides on currency intervention.

My position is such intervention never works.

No Good Currency Choice Except Gold

It’s hard to have a real love affair with dollars, especially at this level. However, it is harder (for the time being) to have a love affair with the Euro.

With property bubbles in Canada, Australia, and China it sure is hard to like the Loonie, the Australian dollar, or the Renminbi (Yuan).

The essence of the matter is there is really nowhere to hide, except gold.

Mike “Mish” Shedlock
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