Euro may see fading reserve demand: James Saft

October 23, 2014

Oct 23 (Reuters) – The euro, long the beneficiary of central
bank reserve buying, may be seeing that support ebb and possibly

If so, and all else being equal, downward pressure on the
euro may mount at a time when the European Central Bank,
struggling to avoid a third recession since 2008, will find this
quite useful.

Global central bank reserves, at more than $12 trillion, are
a massive force in setting the price of currencies and have a
major impact in offsetting or magnifying monetary and economic

One of the big stories of the past 15 years has been the
huge growth of global central bank forex reserves, particularly
in China, which went from having very little at the end of the
last millennium to nearly $4 trillion today. That was pretty
simple: when you have a current account surplus from profitable
exports you do business in dollars and end up holding them.
After all 87 percent of currency exchanges (which by definition
involve two currencies) include dollars, showing its stunning
dominance as an international means of exchange.

But, according to Stephen Jen of hedge fund SLJ Macro
Partners, that exerted downward pressure on the dollar,
as central banks then sought to diversify their reserves in
order to hedge dollar risk. The euro was a beneficiary, at least
up until the euro area crisis.

But though the euro’s share of reserves declined from 2008
to 2011, much of that was a decline in value rather than a
decline due to reserve management.

That may be changing.

“In contrast to the pattern pre-2009, central banks have
stopped accumulating EUR reserves beyond what has been needed to
offset the variations in EURUSD (prices),” Jen and SLJ colleague
Joana Freire write in a note to clients.

“The risk going forward could be an outright divestment from
the EUR by central banks.”

Now while euro area officials would quail at any suggestion
that central banks are retreating from the euro zone single
currency as a stable source of reserve value, that seems
unlikely to be what is happening.

Coming as it does at a time when the ECB is struggling to
make sufficiently stimulative policy, a slowdown in reserve
buying of the euro could be extremely useful, at least to the
euro zone.

There have already been some signs that private investors,
seeing the writing on the wall in terms of monetary policy and
growth, have turned euro-negative, sending it from $1.36 in July
to $1.26 now.


The euro may also suffer, and the dollar benefit, as
emerging markets, which drove the last 15 years of reserve
accumulation, see their economies change.

Not only has China said it wants to accumulate less in
reserves, but many expect the (arguably) largest economy in the
world to now be in an epochal shift from an export-based to a
consumption-based economy.

That process, which may also be happening elsewhere in
emerging markets, may imply that the very strong growth of
central bank reserves may slow, or even begin to reverse.

Jen also argues that Chinese investors will export capital,
as they seek to diversify, something which, if allowed, will
lessen reserve accumulation by the PBOC.

Now remember, countries which export profitably end up
holding dollars. In turn they sell some of these dollars in
order to have more diversified reserves, buying euros, sterling
and yen, among others. That process has been huge,
with global reserves growing by something on the order of $10
trillion in a decade and a half, as globalization deepened. It
has also, you could argue, exerted a steady, subtle downward
pressure on the dollar, as reserve managers sell dollars to buy
other currencies.

To the extent that we think that whole process will slow or
reverse, then we should expect it to drive the value of the
dollar up and the value of the yen, sterling and particularly
euro down.

And of course what is a boon for the ECB, giving them a bit
of needed stimulus, could end up being a headache for the
Federal Reserve, depending on how thing play out.

A rising dollar will crimp demand for U.S. exports and be a
wet blanket on inflation pressure from imported goods. That
might be ok if the U.S. is doing reasonably well, but will pose
an issue if its economy slows.

On the whole, the very long period of huge reserve growth
has been marked by bubbles, crashes and mismanagement.

The transition will be tricky, but may well be for the good.
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be
an owner indirectly as an investor in a fund. You can email him
at and find more columns at

(Editing by James Dalgleish)

No comments so far

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see