The euro is still going strong

One of the stranger things of the last year has been how resilient the euro has traded. Here’s EUR/USD:

Picture 7 The euro is still going strong

How has the euro stayed so (relatively) strong, given the extreme turmoil in Europe? We’ve had sovereign debt crises, bank crises, funding problems, dumb political treaties, and one EU summit after another (to name a few). On the other side of the Atlantic, however, they’ve had decent job growth and a lot of talk about decoupling (and they are much further along in the deleveraging process).

So I was glad to see the FT take on the puzzle. They reach the conclusion that there are two reasons: One is the deleveraging of European banks selling U.S. assets (and thus using their dollars to buy euros); and two is the Chinese keeping the euro strong by buying up assets. Another article mentions lower volume and volatility, and that corporates are not as afraid of tail risk.

These reasons make sense, but the EUR/USD is the most traded currency pair in the world. The liquidity is awesome. I have to wonder whether something else is affecting this. Even during the most volatile of times the euro held up, even though a lot of people bet on it not to.

What’s the central banks’ role in all this? Seeing as central banks are rather secretive, I can only speculate. I would note, though, that just the fact that central banks can intervene as the Bank of Japan and the Swiss National Bank has must be some kind of factor. Just look at equity prices in the ten minutes after the liquidity-facility between large central banks was made public. This might make investors more careful.

Anyway, I wonder if it’s going to stay this way. If the European banks are done selling U.S. assets, the Chinese would stop propping up the euro, or some other factor — do we see a massive selloff? There is also the factor that the euro crisis is not over. At least, I don’t think so. Finally, there is the political factor. I wouldn’t be surprised if some political move was to influence the foreign exchange market. It seems like currencies are less affected by events, though. The ECB’s balance sheet has exploded (although so has all other central banks), but because we’re in a liquidity trap, it’s not working its way to the real economy — or a lower currency.

At the end, I just want to say that I don’t see a lower euro as bad. In fact, it might even help Europe for the euro to trade lower, but until now it has held up.