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Foreign Exchange

Demise of dollar’s reserve status greatly exaggerated, says UBS’s Yu

The 0.8% decline in global dollar reserve holdings for the first quarter of 2011 is not as important as the net decline in euro holdings, UBS FX strategist Geoff Yu says.

Euro reserves among allocated holders (those who report their holdings) show a rise of 5.1% from Q4 2010 to $1.409 trillion at the end of Q1 2011, according to the IMF’s quarterly composition of foreign-exchange reserves (COFER) data. But adjusted for valuation, with the dollar falling 5.8%, this represents a euro sell-off, which Yu pins on persistent sovereign debt worries, including Ireland’s application for a bailout. “So long as the sovereign debt crisis lingers on, sovereign investors will be underweight the currency relative to its overall liquidity and economic position,” he says in his latest comment piece.More notable though, Yu suggests, is sovereign buying of alternative currencies to the dollar, euro, yen, sterling and Swiss franc, as shown in the chart (“other” currencies). Even though registered holders are less keen to buy alternative reserves, Yu notes, a valuation-adjusted $12 billion in raw flow went into these currencies during Q1. This marks a record seventh straight quarterly increase in alternative buying. “Although the total amount of ‘others’ bought since Q3 2009 only amounts to $151 billion, the low supply (liquidity) of these currencies has amplified the price action and contributed to the dollar index’s overall decline in Q1 2011,” Yu says.The trends are consistent with a poll conducted at UBS’s 17th Annual Reserve Management Seminar for Sovereign Institutions, he adds. When asked “what will be the most important reserve currency in the world in 25 years”, most respondents answered “a portfolio of currencies”. Less than 30% believed the dollar would remain pre-eminent and barely 5% named the euro – which scored lower than the choice of “an Asian currency”.“Clearly, diversification from all majors will be the biggest shift that reserve managers will execute in the coming years,” Yu concludes. “Commodity currencies are probably still the most favoured but all emerging currencies are getting a closer look. “As we have pointed out in previous publications, if reserve managers eventually plan on adding fiscal performance to yields and liquidity as benchmarks for investment selection, emerging-market names suddenly look rather attractive in head-to-heads with some traditional reserve currencies.”

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