Magazine article Global Finance

Central Banks Still Shifting from Dollar

Magazine article Global Finance

Central Banks Still Shifting from Dollar

Article excerpt

A growing number of central banks are diversifying their foreign currency reserves away from the dollar and into the British pound, the euro and the yen.

While it's an old story, the issue is still a sensitive one for backers of the dollar. When Federal Reserve Bank of San Francisco president Janet Yellen said in response to a question in early November that some countries may diversify reserves away from the greenback, her comment triggered a brief decline in the dollar.

Alexei Ulyukayev, first deputy chairman of the Russian central bank, said he could increase the bank's yen holdings from almost nothing at present. Russia's reserves are the third largest in the world and have risen about 50% since January to $268 billion due to the country's surging oil revenue. China and Japan, the world's largest holders of currency reserves, could diversify their huge dollar holdings in the future, analysts say. China's reserves recently passed $1 trillion.

Former Fed chairman Alan Greenspan said in a speech in late October that the dollar was being challenged as the world's reserve currency. "We're beginning to see some move from the dollar to the euro, both from the private sector and also from monetary authorities and central banks," he said.

The dollar diversification story is returning to haunt the US currency, as the United Arab Emirates' central bank reasserts its plans to increase its holdings in euro reserves by 10%, as well as raise its share in the British pound and the yen, says Ashraf Laidi, chief foreign exchange analyst at CMC Markets in New York. Although the UAE central bank made similar comments earlier this year, the latest remarks stand out, since they specify that dollar reserves could be reduced to as low as 50% of the total of $25 billion currently held, he says. The central bank noted that its reserves were 98% in dollars and 2% in euros.

The importance of these comments, according to Laidi, was underlined by the fact that they came two days after Switzerland's central bank revealed that it had added yen to its $36 billion in foreign currency reserves and trimmed the share of dollars, while raising its allocation to other currencies. The Swiss National Bank boosted its yen holdings to 4.9% of its reserves from 3% in the previous quarter.

With the Federal Reserve expected to have concluded its interest rate hike campaign and US growth slowing to its lowest levels in three years, world central banks are fulfilling their profit-maximizing functions, Laidi says. They are attempting to sell a portion of their dollar reserves at a relatively high level in the dollar, while adding to their reserve holdings of assets they expect to gain in the medium to long term, such as the yen, the euro, the UK pound and gold, he says.

Meanwhile, the combination of expected monetary policy tightening in Japan and Switzerland and slowing growth in the United States presents considerable risk of capital loss to market participants in the yen and Swiss franc carry trades, Laidi says. Those implementing strategies of borrowing in low-interest-rate currencies to invest in higher-yielding currencies could be in for a rude awakening, he notes. …

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