Thoughts about Dollar's Share of Reserves

The IMF's COFER data is the most authoritative on the currency allocation of central bank reserves. It is updated at the end of every quarter for the preceding quarter. At the end of Dec 2009, Q3 data was released. At the end of this month, Q4 data will be published.

Recall that in Q3 09, the dollar's share of allocated reserves has slipped to 61.6% from 62.8%. The euro's share rose to 27.7% from 27.4%. Sterling and the yen's share together was little changed at 7.5%. The "other" category rose to 2.9% from 2.2%. This would include the Australian and Canadian dollars for example.

We have consistently argued that it is a serious error for observers not to take into account shifts in valuation when trying to understand changes in reserve holdings.

Currency volatility is much greater than bond market volatility and therefore may have a larger impact on reserve valuations. The euro declined by roughly 2.2% over the course of Q4. The yen declined by almost 3.6%. Sterling appreciated by roughly 1.2%.

It should not be surprising to see the dollar share of allocated reserves increase in Q4 09. Moreover given the continued dollar appreciation through most of Q1 10, its share of reserves likely increased again. Indeed, given the currency swings in Q1 (sterling ytd -7.3%, euro -5.1%), the shift may be even more pronounced in Q1 10 than Q4 09.

It is possible that given the appreciation of the Australian and Canadian dollars in Q4 09, that the reserves denominated in the "other" category also rises.

We'd note that the Fed's custody holdings for foreign central banks increased by almost $100 bln in Q4 09. In contrast, the TIC data shows foreign official holdings in Q4 barely edged higher (~$5 bln). What the increase in the custody holdings but not the TIC data may suggest that the purchases by foreign central banks may not be going through US banks.

Bottom line: The decline of the dollar as a reserve asset has been exaggerated by its depreciation. In recent months, the dollar has appreciated and this will likely impact the next reserve figures due out at the end of the month. Countries that diversified the most into euros and sterling are vulnerable to the biggest shift in valuation for the Q4 09 figures and Q1 10 figures.