Global Central Banks FX Reserves Rising: Implications For FX

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Includes: FCA, FXE, FXI, UDN, UUP
by: Orbex

Summary

A downward trend in USD could see self-reinforcing support from central banks, particularly as the EUR percentage share of global FX reserves has been particularly low over recent quarters.

The journal of the Chinese Securities this week noted the “yuan is expected to increase its two-way fluctuation in the near term”.

The importance of this for FX markets can be seen in the recent strength in EUR which has come alongside resurgent strength in China’s FX reserves.

By James Harte

PBoc Reserves Rise Again in July

The latest data shows that PBoC FX reserves rose again in July, reaching around $3.1trln. Central banks in developed economies have been steadily adding to their reserves, which is a trend likely to develop further if the use continues its downward trajectory.

Indeed, a downward trend in USD could see self-reinforcing support from central banks, particularly as the EUR percentage share of global FX reserves has been particularly low over recent quarters. As such, central banks could start to add to their EUR FX reserves even if the total amount of reserves doesn't grow.

Chinese Reserves Hit Highest Levels Since 2014

The reported $23.9bln increase in China's reserve holdings over July was slightly above analyst estimate and despite being down around 4% year on year, reserves have been steadily increased over the last six months. Data also shows that three of their last four monthly increases have been the biggest increases since early 2014 reflecting that after two years of consistent depletion, FX reserves are now being restocked.

Key Domestic Factor

In terms of domestic factors fueling this trend, one is clearly the movement in the exchange rate with CNY now trading around 6.70 against USD, marking its strongest level since October 2016. Alongside this move, concerns about a sustained decline in the currency have now largely subsided

CNY looks to trade on a relatively stable basis over the short/medium term horizon with the US and China preparing for President Trump's visit to the country later this year. Markets also await the 19th national Congress and the US Treasury's semi-annual review of global FX and trade policies.

CNY Effective Trading Band Increasing?

Another area to highlight is the growing speculation surrounding a possible increase in CNY's effective trading band. Indeed, the journal of the Chinese Securities this week noted the "yuan is expected to increase its two-way fluctuation in the near term".

Further strength in CNY will create more scope for China to further build its FX reserves over the coming months.

Global Central Banks Building Reserves

However, it is not just China that is building their FX reserves, other big, developing market economies are also building their base including Taiwan, South Africa, Brazil, Hong Kong, Singapore, Russia, India and Mexico where FX reserves have been rising steadily since 2008 and now stand at record levels.

This is an important trend to track as periods of sustained USD weakness are generally linked with higher central bank reserve building and the bigger developing market central banks while periods of stronger USD trading typically see lower levels of growth in FX reserves.

Implications For FX

The importance of this for FX markets can be seen in the recent strength in EUR which has come alongside resurgent strength in China's FX reserves. EURUSD price movement has displayed a strengthening connection with movements in Chinese FX reserves and indeed, movements in global FX reserves with periods of reserves building seeing stronger EUR and vice versa.

As such, the downward trend in USD could become self-enforcing as central banks build their currency reserves to slow down rising domestic currencies then convert some of those USD's into other developed liquid currencies like EUR.

EURUSD Technical Perspective

After breaking out above the 2015 high, the price has now retraced and is retesting the level from above. This is now a key price pivot for EUR - a break back below the level could indicate a double top and signal a deeper correction lower. Alternatively, if the price can find support at the retest of the level, the focus will remain on the upside with the 50% retracement from 2014 highs the next key objective.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.