ORLANDO, Fla., Oct 11 (Reuters) – An apparent decline in global foreign exchange reserves this year is just a mirage tied to the strength of the U.S. dollar – but reality could yet materialize and give the world another boost. troubled US bond market.
The narrative around a reduction in reserves has gained traction but does not warrant further examination. Reserve managers, on the whole, have been net buyers of Treasuries this year, for example.
It is true that an increasing number of central banks are intervening in the currency market to sell dollars, and the face value of their foreign exchange reserves and US Treasury holdings has declined.
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But the overall decline was mainly due to valuation effects. In the case of Treasuries, this was entirely due to falling prices.
The latest available data from the International Capital Treasury (TIC) shows that the nominal value of foreign official holdings of Treasury bills stood at $3.709 trillion in July, up from $3.913 trillion last December.
The nominal $204 billion drop is on track to be the largest annual decline since 2016, and the second largest on record.
But the research of Fed economists Carol Bertaut and Ruth Judson, who help compile and present the ICT data, is instructive. Their models released earlier this year estimate net monthly flows of valuation effects.
Their analysis shows that valuation effects explain a decline of nearly $270 billion in total holdings this year and that central banks have actually purchased nearly $65 billion of US Treasuries in the first seven months. of this year.
They were net buyers in five months, and sellers in April and May.
“Official holdings are falling, but not because central banks are selling. So far this year, that’s been due to valuation effects,” said Frank Warnock, a professor at the University of Virginia and senior research adviser to from the Fed.
“But we don’t know what will happen in the coming months,” he added.
Central banks in Asia and Latin America, including the Bank of Japan, have recently intervened directly in the foreign exchange market by selling dollars for local currency. This may have involved selling US Treasuries.
But Bertaut and Judson’s calculations challenge some of the more frenzied market chatter in recent weeks that the soaring dollar could force central banks to crush US bonds for currency intervention purposes.
They are as accurate an interpretation as any ebb and flow of central bank demand for Treasuries. The estimated $270 billion valuation change reflects a 7% decline from end-2021 holdings, broadly in line with the 7.5% drop in Bank of America’s aggregate US Treasuries Index during the period.
Central banks bought into this slowdown, but it is unclear whether this continued into August and September, when the BofA Treasuries index lost a further 6% and central bank foreign exchange intervention s is accelerated.
Partial data on deposits from the New York Fed suggests that there was net selling in August and September.
The fear is that intervention in the foreign exchange market will involve the sale of Treasuries, opening a potentially serious “catastrophic loop”: yields rise, making the dollar more attractive, pushing the dollar higher, forcing central banks to intervene again and in greater numbers.
However, we are not yet at that stage.
“Only a handful of countries seem to be really intervening in the forex market by selling Treasuries,” says Marc Chandler, head of FX strategy at Bannockburn Global and a seasoned foreign exchange reserve watcher.
Until the next TIC reports are released – August data will be released on October 18 – we can only speculate. China and Japan, the world’s largest holders of foreign exchange reserves, released September data on reserves, but neither gave a breakdown of currency or asset mix.
The nominal value of China’s foreign exchange reserves stood at $3.029 billion in September, the lowest since March 2017. Since July, the last month of official TIC data, they have fallen by $75 billion, or 2.4%.
Japan’s reserves fell to $1.238 billion in September, also the lowest in five and a half years. They have fallen by some $85 billion, or 6.4%, since July. In nominal terms.
It should be noted, however, that the broad value of the dollar rose 6% in those two months, while the BofA Treasuries index fell 6%. These are two powerful valuation shifts that could skew the numbers significantly.
Steve Barrow, head of G10 strategy at Standard Bank in London, warns that sales of Treasuries by the official sector could ultimately require counteraction from the Fed and others.
“There is a growing danger that dollar strength and substantial monetary intervention will serve to make global monetary conditions too tight,” he wrote on Monday.
(Views expressed here are those of the author, columnist for Reuters.)
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By Jamie McGeever; Editing by Andrea Ricci
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