The release of international reserve data by the IMF over the new year was always likely to receive a lot of attention. After all, it is commonly believed that central bank flows have assumed a rising importance in the currency market during the last year. Indeed, data on foreign exchange turnover show decreasing levels of participation from the private sector, implying that the official sector has had a larger degree of influence over price levels in the currency market.
According to the IMF, total FX reserves grew to a fresh record of $10.8 trillion in the third quarter of 2012, a 6% annual increase. Allocated reserves for EM economies grew by $71 billion, and advanced economies added $100 billion in reserves during the quarter.
The figures that drew the most attention were those for the allocation of EUR within central bank reserves, which eased from 25% in the second quarter to 24.1% in the third quarter.
Jens Nordvig, head of FX strategy at Nomura, says since the value of the EUR was rising in the third quarter of last year, the drop in the proportion of reserves held in the EUR cannot be put down to valuation effects.
“Instead, we view it as evidence of active diversification away from euros,” he says.
Of course, selling of EUR from the Swiss National Bank (SNB) was evident in the IMF data. Nomura estimates the SNB sold $82 billion-worth of EUR during the quarter as it diversified the EUR it acquired, maintaining the SFr1.20 floor it imposed in EURCHF into other currencies.
However, it was not just the SNB that was cutting its EUR reserves.
The data show EM central banks diversified away from the EUR as well, with outflows worth about $30 billion, according to valuation-adjusted calculations from Nomura.
That means the share of reserves held by EM managers in EUR fell to 24.7% in the third quarter, down from 25.8% in the second quarter, and its lowest level since the third quarter of 2002.
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“Considering that this trend arose in the midst of considerable euro strength, the pattern will persist as central banks diversify away from the euro and into other currencies,” says Nordvig.
However, as Steve Barrow, head of currency strategy at Standard Bank, points out, while the IMF figures suggest that central banks lightened their EUR holdings in response to the eurozone debt crisis, the recovery of the single currency and the easing of the crisis since then suggest this process might have turned around in the fourth quarter of the year.
In any case, it appears there has not been a wholesale shift by reserve managers away from EUR and into USD. The USD share of global reserves was essentially unchanged at 61.8%.
Instead, reserve managers, in advanced and EM countries, continued to build up their stockpiles in what the IMF defines as “other” currencies, such as the AUD and CAD, of which central banks bought $4 billion and $15 billion-worth respectively in the third quarter of last year.
That means stockpiles in other currencies, which covers everything other than USD, EUR, GBP, JPY and CHF, have risen by almost 15% during the past year.
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It would seem that the shift in reserve allocations did not simply reflect concerns about the eurozone debt crisis. Instead, there appears to be a structural shift, whereby reserve managers are searching for other reserve assets, rather than just a knee-jerk reaction to the problems in the eurozone.
“Indeed, when we listen to those central banks that are more open about their reserve plans, like the Russian central bank for instance, we observe a clear desire to add currencies such as the Australian dollar and the Canadian dollar,” notes Barrow.
Of course, as the IMF itself has noted, there is a shortage of investible “safe” assets in which reserve managers can invest.
Debt markets in other currencies such as CAD and AUD are simply not large or liquid enough to satisfy global reserve manager demand – a record 75% of Australian government debt is foreign-owned, for instance.
So while the eurozone debt crisis might have tempered demand for EUR reserve assets, a wholesale retreat by reserve managers from the single currency is impractical. Indeed, given the stabilization that has occurred in the eurozone since the third quarter and the resulting rally in risky asset, it is likely that some of those outflows have been reversed.