Dollar Diversification Resumes as Reserves Increase
Central banks are signaling their confidence in the global economic recovery by once again diversifying their currency reserves away from the U.S. dollar as overall holdings climb to a record $11.4 trillion.
The greenback accounted for 61.44 percent of the money held by central banks in the third quarter of 2013, down from 61.76 percent in the previous period and the first decline in almost a year, the International Monetary Fund said in data published Dec. 30. What the IMF calls “other currencies” rose to 2.87 percent of reserves, from 2.85 percent in the second quarter, after plunging from 5.89 percent a year earlier.
“You’ll see reserve diversification pick up again,” Kevin Hebner, a foreign-exchange strategist in New York at JPMorgan Chase & Co. said in a Jan. 2 phone interview. “It would seem reasonable that we see increases in the allocations to the euro going forward, as well as to the Canadian and Australian dollars and the IMF’s ‘other’ category.”
The global economy expanded by 2.49 percent from July to September, the fastest pace since the first quarter of 2012, while strategists surveyed by Bloomberg predict U.S. growth will approach this year levels last seen before the global financial crisis. The improving outlook is helping damp swings in currency exchange rates, with JPMorgan’s Global FX Volatility Index falling from a one-year high reached in June.
While the amount allocated in U.S. dollars rose by about $50 billion to a record $3.8 trillion as central banks’ reserves reached an all-time high, the greenback’s share of the holdings fell for the first time since it dropped 0.16 percentage point in the final quarter of 2012. The IMF published its findings in its quarterly Currency Composition of Official Foreign Exchange Reserves report.
Before the September 2008 collapse of Lehman Brothers Holdings Inc., the share of central banks’ currency reserves parked in U.S. dollars was falling by about one percentage point a year, and that pace of declines is likely to resume, according to Hebner. The greenback’s share of the holdings peaked at 72.7 percent in June 2001, IMF data show.
The euro accounted for 24.16 percent of reserve holdings in the third quarter of 2013, up from 23.93 percent in the previous three months, according to the IMF. The common currency’s share was just 18 percent when it debuted in 1999, and peaked at 28 percent in September 2009.
Turkey’s central bank sold $600 million at a foreign-currency auction on Dec. 30, the most since July 10 and taking its sales of the U.S. currency to $3.4 billion since a corruption probe came to light on Dec. 17 and rattled investor confidence. The lira, among the three worst performing currencies among emerging-market peers in December, declined 6 percent versus the greenback last month.
South Korea’s foreign-currency reserves jumped by $6.3 billion in October, the most in two years, to a record $343.2 billion, according to official data. The increase suggests the central bank had been intervening “a lot,” Isabelle Mateos y Lago, the International Monetary Fund’s Korea mission chief, said in a Nov. 1 interview in Seoul.
Even with the diversification, the importance of the U.S. dollar and euro to the global economy will ensure that’s where policy makers will continue to park most of their cash, according to Bryan Zarnett, a currency strategist at Citigroup Inc., the world’s second-largest foreign-exchange trader.
“The U.S. dollar and euro will continue to be the main reserve currencies,” New York-based Zarnett said in a Jan. 2 phone interview. “We expect this pattern to continue as the U.S. dollar and euro have low beta and high liquidity.” Beta measures the degree to which a currency is tied to movements in the overall market.
The Washington-based IMF’s “other currencies” category, which comprises less-traded tenders that may include the New Zealand dollar, grew from July to September 2013, after sliding from the third quarter of 2012.
This category included the Canadian and Australian dollars until those currencies were broken out back through the fourth quarter of 2012. The share of reserves allocated to the loonie, named for the image of the aquatic bird on the C$1 coin, rose to 1.82 percent in the latest data, from 1.81 percent in the prior quarter. The figure was just 1.5 percent when it was first reported individually by the IMF.
Australia’s dollar saw its share of reserves fall to 1.65 percent in the third quarter of last year, from 1.67 percent in the previous three months, according to the IMF. The drop may be partly due to the Aussie’s 14 percent slide versus the greenback last year, the most since 2008. Its allocation is still up from 1.47 percent in the final quarter of 2012.
Total global currency reserves rose by $298 billion during the three months ended Sept. 30 to their all-time high, with the overall figure now almost 10 times higher than the $1.61 trillion reached in 1999, IMF data show. After adjusting for exchange-rate movements, overall holdings increased $211 billion in the third quarter, after climbing $59 billion in the prior period, according to Credit Suisse Group AG.
The pace of economic recovery, particularly in the U.S., is helping fuel investor demand for riskier assets and giving central banks the confidence to once again start to diversify their reserve holdings. The improvement has allowed the Federal Reserve to reduce the bond purchases it uses to pump money into the economy from a monthly $85 billion.
JPMorgan’s Global FX Volatility Index fell to 8.6 percent as of 9:47 a.m. in London, down from the high over the past year of 11.96 percent reached on June 24, data compiled by Bloomberg show. Stocks are also benefiting from the improved economic outlook, with the benchmark Standard & Poor’s 500 Index (SPX) closing at a record-high 1,848.36 on Dec. 31, after surging 30 percent last year for its biggest annual gain since 1997.
U.S. gross domestic product will expand 2.6 percent this year and 3 percent in 2015, the fastest pace since 2006, according to Bloomberg surveys. The world’s largest economy will outstrip growth in its developed Group-of-10 peers by 1.4 percentage points over the next two years, the surveys predict.
The U.S. dollar’s share of central-bank reserves fell in the third quarter of 2013 as the greenback weakened. The Bloomberg Dollar Index, which tracks the currency against 10 major peers, tumbled 2.8 percent in the three months through September, the most since 2010. Over the whole of 2013, the gauge rose 3.5 percent, the biggest appreciation since 2008.
The Japanese yen, whose share of reserves fell to 3.86 percent in the third quarter from 3.89 percent in the previous period, weakened about 18 percent against the dollar in 2013, the most in 34 years.
The yen posted the biggest decline among its 10 major peers last year, falling almost 17 percent as measured by Bloomberg Correlation-Weighted Currency Indexes, as the Bank of Japan unveiled an unprecedented monetary easing program. It tumbled to a more than five-year low of 105.44 per dollar on Jan. 2.
The U.K. pound’s allocation in central-bank reserves increased to 3.92 percent, from 3.82 percent, IMF data show. Britain’s currency strengthened 1.9 percent against its U.S. counterpart last year and almost 9 percent in the second half, before reaching $1.6603 on Jan. 2, the strongest level since August 2011. The pound has been supported by investor speculation the Bank of England will be among the first major central banks to tighten monetary policy as unemployment falls.
The 18-nation euro climbed 8.4 percent against nine developed-market peers in the past year, the biggest gain in Bloomberg Correlation-Weighted Currency Indexes, as the trading bloc emerged from its longest-ever recession.
“There was quite a bit of a decrease in the euro’s share of global reserves during the euro-zone crisis, and that trend seems to have bottomed,” Anezka Christovova, a London-based foreign-exchange strategist at Credit Suisse, said in a Jan. 3 phone interview. “As credit risk and euro-zone break-up risk have receded, the euro, which has quite a large asset market, should again attract demand. This will come as the trend of rising overall levels of global reserves continues.”
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