Reserve managers abandon the euro; intervention recycling equation altered

By:
Peter Garnham
Published on:

The world’s reserve managers cut the share of the euro in their FX stockpiles in the fourth quarter to the lowest level since the eurozone debt crisis erupted, according to figures from the IMF – news that could alter the dynamics of the FX market.

The evaporation of faith in the euro as a reserve currency comes despite the pledge in September from Mario Draghi, president of the ECB, to do “whatever it takes” to ensure the survival of the single currency.

Indeed, the data suggests that even as the unveiling of the ECB’s OMT bond-purchasing plan helped soothe fears about the future of the single currency and helped ease tensions in the eurozone debt market last autumn, reserve managers reduced the proportion of euros in their FX holdings.

The IMF’s quarterly Cofer data, which tracks the level of global FX reserves, showed central bank reserves rose to a record $10.9 trillion at the end of 2012. That represented a rise of 7% over the year.

Most central banks reveal the currency allocation of their reserves, although China, the world’s largest FX reserve holder with stockpiles of $3.3 trillion, regards the information as a state secret and does not provide a breakdown.

 Allocation euro falls; allocation to dollar is flat
 

However, figures for allocated reserves show that while the dollar remains the reserve currency of choice, with the share denominated in the US currency remaining stable at 61.9%, the rise in euro holdings are not keeping pace with overall reserve growth.

The share of allocated reserves denominated in the euro dropped to 23.9% at the end of 2012. That is down from 24.6% at the end of 2011, 26.0% at the end of 2010 and a peak of 28.4% in the third quarter of 2009.

“It seems reasonable to say that since the start of the eurozone crisis, the appetite for euros has collapsed among central banks that report the make-up of their reserves,” says Simon Derrick, global head of FX strategy at Bank of New York Mellon.

“So much for the euro’s continued role as a reserve currency.”

If reserve managers are shunning the euro, and with allocations in sterling, yen and the Swiss franc relatively stable, the question is which currencies are benefiting?

The answer, according to the data, is what the IMF defines as “other currencies”.

That category covers all reserves that are not held in the dollar, euro, sterling, Swiss franc or yen, and is thought to mainly consist of Australian and Canadian dollars. Indeed, starting next quarter the IMF plans to break out the Australian and Canadian dollars from the “other” category.

 Allocation to other currencies jumps to 6.1%
 

IMF data show that the share of allocated reserves in other currencies rose to a record 6.1% by the end of the fourth quarter of 2012, meaning that $54.8 billion-worth of reserves were added to that category last year.

For context over the growth of the category, and evidence of global reserve managers’ increasing desire to diversify their FX stockpiles, 5.4% of allocate reserves were denominated in other currencies at the end of 2011, and just 2.1% at the start of 2009.

Therefore, just as the euro’s popularity among reserves managers has been falling, the figures point to the increasing importance of the Australian and Canadian dollars as reserve currencies.

That has important implications for the currency market.

As Greg Anderson, strategist at Citi, notes, one of the dominant forces in the FX markets during the past decade has been central bank intervention recycling.

The theory goes that as emerging market reserve managers acquire dollars through intervention in their domestic currency, they then turn around and sell a portion of those dollars to buy other G10 currencies.

That has supported EURUSD during periods of risk-on trading as emerging market central banks intervene to suppress the value of their currencies in the face of increasing portfolio inflows.

Anderson says even if data show that the amount of reserve accumulation, and therefore recycling, is slowly receding in 2013 among those reserve managers that report reserve totals on a weekly basis, it has not gone away entirely.

Therefore, he says, the shifting of reserve manager portfolios out of the euro and into the Australian and Canadian dollars is likely to continue.

“This process should keep a quiet bid in the market for these two currencies,” says Anderson.

There is also a wider implication for EURUSD.

Emerging market central banks’ desire to reduce their exposure to the euro should prevent the current round of quantitative easing by the Federal Reserve from pushing EURUSD higher through the reserve recycling mechanism, as it did during QE2.