BCA Research: Reserve managers offer little support for USD
Although official inflows into US assets are preventing the dollar from collapsing, they cannot lead to sustained strength in the currency, says BCA Research, one of the world’s leading independent providers of global investment research.
Figures from the IMF showed total FX reserves grew by $935 billion last year to stand at a record $10.2 trillion. Harvinder Kalirai, chief strategist at BCA, says a few trends are particularly noteworthy.
First, he says, central banks remain the biggest financiers of the US current account deficit.
“Foreign monetary authorities increased their dollar holdings by about $315 billion last year,” he says. “If an estimate for unallocated reserves is made, central banks may have bought an astonishing $600 billion of dollar assets in 2011.”
But although official inflows are preventing a slide in the dollar, they cannot boost the currency on a long-term basis, Kalirai warns. For that to happen, the capital inflows need to come from foreign private investors, who are motivated by return-seeking behaviour.
“At the moment, long-term private capital inflows are weak and the US basic balance remains at a near record deficit,” says Kalirai. “This warns that there is little underlying fundamental support for the dollar.”
Second, he notes that reserve managers are not dumping the euro, indeed holding of the single currency rose to a record high of €1,100 billion at the end of 2011.
Kalirai believes that euro purchases are the result of portfolio rebalancing.
“As FX reserves continue to grow, a fixed proportion needs to be reallocated to the euro to keep its share of total reserves constant,” he says.
“The broad weakness in the US dollar and a regular reallocation of rising reserves are two key reasons for the resilience in EURUSD.”
Finally, Kalirai says the minor currencies are the big story as regards the diversification of reserves.
Indeed, recently, the allotment of global reserves to non-G5 currencies has been rising sharply.
The IMF reports only the currency breakdown of FX reserves for the USD, EUR, GBP, JPY and CHF.
The remainder are classified simply as “other currencies”. From about 2% in early 2009, “other currencies” now account for over 5% of FX reserves. The holdings of these alternative currencies are increasing by about $100 billion a year.
Kalirai speculates that this group largely consists of the dollar bloc commodity currencies – CAD, AUD and NZD – and the Scandies – SEK and NOK.
“If global investors – both central banks and private investors – continue to boost allocation to these fairly small and illiquid currencies, then these currencies will be prone to significant overshoots,” he says.
“We expect that ongoing FX reserve diversification will benefit the dollar bloc and Scandi currencies the most.”