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Official FX
reserves have increased six-fold since 2000. However, since
mid-2014 the growth rate has decelerated sharply, due to the
stronger USD, as well as stress in some emerging markets. In fact,
total reserves invested by emerging markets declined for the first
time in twenty years.
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The
proportion of disclosed allocations invested in USD assets
increased to 62.9% in Q4, the highest percentage since 1Q2009.
Before 2008 the USD allocation was declining by about 1ppt
annually, but since the financial crisis the proportion stabilized
and has recently been drifting higher.
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The
proportion invested in EUR assets declined significantly in Q4, to
22.2%, the lowest percentage since 2Q2002. Further, the decline
experienced over the last year was the sharpest witnessed since the
EUR’s inception. Prior to 2009 the allocation to EUR assets was on
the rise. However, during the last four years this trend has
reversed, with the allocation falling by roughly 1ppt per year.
Given the depreciation in the EUR in 1Q15, we expect the EUR
allocation to decline to 19.8% with the next COFER release. The
primary beneficiary is likely to be the USD.
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Currency
depreciation during the quarter caused passive declines for
everything except the USD. However, reserve managers swam against
the strong USD tide, concerned that FX movements were driving
non-USD allocations below target. Net of currency effects, they
were significant buyers of CHF and JPY, and moderate buyers of GBP,
CAD and AUD. However, they allowed the weaker EUR to drive that
allocation lower, pretty much unresisted. This reflects medium-term
concerns regarding their prodigious exposure to the common
currency.
The IMF’s COFER report
for 4Q2014 shows how allocated FX reserves are invested across
seven currencies (plus “others”). Since 2000, official FX reserves
have increased sixfold (Table 1) with 62.9% of the allocated total
being invested in the USD (the highest proportion since 1Q2009) and
22.2% in EUR assets (the lowest since 2Q2002). In addition to the
five traditional reporting currencies, in 4Q12 the IMF added the
CAD and AUD to those reported in its quarterly COFER report (Table
2).
Table 1: USD allocation soars, while the EUR’s share plummets (with
the rest managed in a tight band)
Official FX
reserves and disclosed allocations at year-end for five currencies
and “others”
Source:
IMF, J.P. Morgan
* This
table is intended to demonstrate the medium-term trend, so CAD and
AUD allocations (which were first disclosed in 4Q12) are included
in “Others.”
One worrisome trend is
that we are flying increasingly in the dark as allocated reserves
now constitute only 52.5% of the total. This represents a record
low, down markedly from 78.4% in 2000 (i.e., it has been declining
by about 2ppt per year). At this pace, by 2016 currency allocations
may be disclosed for less than half of global FX reserves. The IMF
is rightly concerned about the risk this lack of transparency poses
for financial markets.
The Dollar Trap: USD
allocation climbs to its highest since 1Q2009
The proportion of
disclosed allocations invested into USD assets increased from 60.8%
in Q1 to 62.9% in Q4 of 2014. Before 2008 the USD allocation
appeared to be declining by about 1ppt per year (for example, from
71.1% in 2000 to 63.8% in 2008). However, since the financial
crisis of 2008-09 the proportion invested in USD assets stabilized
(fluctuating in a tight 60.7 to 62.5% band) and has recently broken
out to the upside. Looking ahead, we expect that the USD allocation
increased even further in 1Q2015, given the over 4% appreciation in
the broad dollar during the quarter. Beyond 2015, however, a return
to the pre-Lehman declining trend seems likely as FX reserve
managers remain determined to (eventually) diversify away from the
greenback.
Table 2: Quarterly data shows a similar pattern with a rising and
disproportionate USD allocation, a declining percentage into EUR
assets, and remarkably stable shares for the remaining five
currencies
Official FX
reserves and disclosed allocations for seven currencies and
“others” over the last nine quarters (CAD and AUD were added in
4Q12)
Source:
IMF, J.P. Morgan
The proportion
invested in EUR assets plummets to its lowest since
2Q2002
The proportion of
allocated FX reserves invested in EUR assets has declined
significantly, from 24.3% in Q1 to 22.2% in Q4 of 2014, the
smallest proportion in over a decade. Further, the 2.2ppt decline
during the last year represents the largest annual reduction in the
EUR allocation ever (well, since inception in 1999).
Prior to 2009 it seemed
that that the percentage invested in EUR assets was on an
inexorable rising trend. More specifically, the allocation was
increasing by about 1ppt per year (e.g., it had increased from
17.6% in 1999 to 28.0% in 3Q2009). However, during the last four
years this trend has reversed, with the allocation to EUR assets
declining by roughly 1ppt annually.
Looking ahead, we
expect the EUR allocation to decline over coming years, partially
due to currency weakness (we forecast EUR/USD to decline to 1.05 by
4Q15, largely driven by Fed hikes), but more fundamentally
resulting from diversification into higher yielding currencies (EUR
yields are likely to remain lower for longer, given that the ECB’s
QE policy should remain in place well into 2H16).
During 1Q2015 we
project the EUR allocation to decline significantly further. First,
the EUR/USD declined by about 11% during the quarter. Further,
recent COFER releases have demonstrated that reserve managers are
not swimming terribly aggressively against the EUR undertow. To a
large extent they have responded passively, allowing the weaker
currency to drive the EUR allocation lower. Presumably this
reflects medium-term concerns regarding their prodigious exposure
to the common currency. Consequently, we expect the EUR allocation
to decline to 19.8% with the next COFER release.
Net of currency
effects, reserve managers were significant buyers of JPY and
CHF
The JPY allocation has
been remarkably stable, at 4.0% for three consecutive quarters
(table 2). Further, the JPY allocation has stayed in an extremely
tight 3.8 to 4.1% band since 2012. This strongly suggests FX
reserve managers have a target allocation in mind for the JPY. This
is demonstrated by table 3 which shows that, when faced with the
10.3% depreciation in the JPY in Q4 of 2014, reserve managers
actively increased their holdings. So much so that the net decline
in exposure was only 1.4%. They reacted similarly in the previous
quarter, when the JPY depreciated by 8.0%, but reserve managers
bought JPY assets actively so that their net exposure only declined
by only 3.7%, or by less than half the fall in the
currency.
Regardless, over time
we expect the JPY allocation to fall, partially due to currency
weakness (we forecast USD/JPY at 1.28 by 4Q15), but also due to the
extremely low JGB yields that are likely to continue for years to
come. Together these factors should encourage FX reserve managers
to shift into higher yielding assets.
The CHF allocation has
also been extremely stable, printing 0.3% for eight consecutive
quarters. Further, and similar to the JPY, reserve managers have
been actively swimming against the tide (table 3). For example, in
response to Q4’s 3.2% currency depreciation, reserve managers
actively increased their holdings so much that the CHF actually
experienced a net gain in exposure during the quarter.
However, net of
currency declines, they were only moderate buyers of GBP, CAD and
AUD
The GBP allocation held
steady at 3.8% and has remained in a tight 3.8 to 4.0% band since
2012 (table 2). This suggests FX reserve managers have a target
allocation in mind for the GBP. To illustrate, table 3 demonstrates
that, when faced with the 3.7% depreciation in the GBP in Q4 of
2014, reserve managers actively increased their exposure so that
the net decline was only 2.9%. They reacted similarly in Q3, when
the GBP depreciated by 5.3%, but reserve managers bought actively
so that their net exposure only declined by 2.7%, or roughly half
the fall in the currency. However, with the next COFER release we
do expect a break below the currency’s post-2012 range, as the GBP
has depreciated by over 4% during 1Q15.
Allocations to the CAD
and AUD have only been reported for nine quarters and still
represent a relatively small proportion of total allocated reserves
(1.9% and 1.8%, respectively). In Q4 of 2014 the CAD depreciated by
3.5%, but reserve managers actively bought a moderate amount so
their CAD exposure declined by a less extreme 2.8%. Similarly, the
AUD weakened by 6.7% in Q4, but exposure to AUD assets only fell by
5.5%. In the next COFER release both currencies are likely to see
somewhat smaller allocations, reflecting the sizeable currency
depreciations they have both experienced. However, over the
medium-term we expect allocations to both CAD and AUD assets to
rise, as FX reserve managers diversify away from the USD and EUR.
Such a trend should provide a nice tailwind for the two commodity
currencies over coming years.
In sum, table 3
demonstrates that, net of currency effects, reserve managers were
buyers of all currencies except the USD. Reserve managers were
swimming against the strong USD tide, concerned that FX movements
were driving the non-USD allocations below their targets. This
theme is likely to be equally prominent in the next COFER
release.
Table 3: Change in USD value of FX reserves managed in each of the
seven currencies, as well as % change in the underlying currency
vs. USD over the last four quarters
For
example, in 4Q2014 the EUR depreciated by 3.6%, while the value of
FX reserves in EUR assets decreased by 3.3%. This implies that, net
of currency effects, reserve managers increased their EUR exposure
by a moderate 0.4ppts.
Source:
IMF, J.P. Morgan
Our expectations for
trends over the longer term are informed by a May 2013 report
published by the IMF, “Survey of Reserve Managers: Lessons from the
Crisis.” The report presented details from a survey of FX reserve
managers (67 countries responded). Their results emphasized that
56% of respondents were considering adjusting the currency
composition of their reserves, with 74% of those contemplating a
shift to G10 currencies other than the G4 (with highest interest
expressed in the AUD and CAD). Overall, FX reserve managers appear
to hold quite poorly diversified portfolios, with over 85% of their
assets invested in just two currencies.
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FX reserve growth has slowed, reflecting the strong USD as well as
EM stress
Table 4 shows total FX
reserves as well as amounts for the eighteen countries with the
largest holdings (note that this table is not based on the IMF’s
COFER data). The key takeaway from the table is that the USD value
of FX reserves has slowed markedly over the last year. This trend
is especially noticeable since July 2014 and coincides with the 15%
appreciation in the USD during that time period. A second key
driver of slower reserve accumulation has been the level of stress
affecting several emerging markets.
The value of total FX
reserves is down 0.6% over the last year, with the largest
percentage declines experienced by Russia and Malaysia (falling by
29.2% and 15.5%, respectively). Further, the three largest reserve
managers have all experienced yoy declines. Among large managers,
the key exceptions to this trend include Switzerland, Hong Kong and
India, all of whom have been quite active in currency
markets.
However, the 1-year
decline is a bit deceiving, as FX reserves actually rose by 2.5%
during the first seven months of 2014, but have declined by 3.2%
since then. One key reason for the decline is the strong USD. To
illustrate the logic, imagine that 35% of reserves were invested in
non-USD assets and that they declined in USD terms by 10% (say,
assuming a 5% local currency return to partially offset the USD’s
15% appreciation). In such a scenario we would expect the USD value
of reserves to fall by 3.5%, quite close to the 3.2% that actually
transpired.
Table 4: The growth of FX reserves has slowed
dramatically
Top FX
reserve countries, with China leading the pack. It accounts for
33.0% of the global total and its FX reserves have grown, on
average, by 19.3% per year over the last decade (but shrunk by 4.0%
since mid-2014).
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