An interesting observation from Bank of New York Mellon’s FX team on Wednesday (our emphasis):
Indeed, at the risk of over-simplification, it appears to us that we have now entered a new era in financial history – an era in which certain governments are seriously deliberating the USD’s hegemony as a reserve currency and even its stability over the longer-term.
They draw that conclusion from the apparent indifference of the foreign exchange markets to the growing political crisis in the UK. There have been critical revelations about political expenses, with Alistair Darling’s future as UK Chancellor of the Exchequer being questioned, and yet UK sterling has risen a staggering 13 per cent versus the dollar in the last four weeks:
The moves also come despite a concerted dollar-reassurance mission by US Secretary Timothy Geithner to Beijing this week. However, as BNY Mellon’s Neil Mellor observes:
Given that the hands of the Federal Reserve are tied in the face of a continued threat of deflation, to quell such concerns, Mr Geithner will have to proffer a concerted plan of campaign to reign in the US fiscal deficit.
However, if this is to be forthcoming in a timely fashion, then it may entail decisions that could well jeopardise incipient signs of stabilisation in the US economy – all of which explains investors’ scepticism in the face of Mr Geithner’s reassurances. Moreover, far from underpin the USD, Mr Geithner’s trip to China has coincided with an intensification of the unit’s downtrend and the associated shift of investment flows out of the Treasury market to higher yielding destinations.
This is of no small significance: data released yesterday showed that in May alone, South Korea saw the largest rise in its FX reserve holdings ever recorded..
Although, even BNY Mellon draw attention to the fact that there are still conflicting messages coming from the dollar surplus-holding nations.
A Reuters report quoting anonymous central bank sources on Wednesday suggested countries like China, Japan, India and South Korea would in fact be unlikely to change reserve policies, even in the event of a US sovereign downgrade. The source said that was because they view their US Treasuries investments as a means to a global partnership with the US more than anything else.
As Reuters reported the source saying:
“They (central banks) are not competing against mutual funds or hedge funds. If they make a loss it’s okay, as long as they are sticking to the investment policy imposed from the very top, because they are not concerned with short-term gains or losses,” said a person familiar with the thinking of Chinese reserve managers, who spoke on condition of anonymity because of the sensitivity of the issue.
“The U.S. Treasury bond is a partnership the Chinese government holds,” the person added, stressing that selling down dollar-denominated assets could hurt the political relationship between China and the United States.
Of course, they might just be keeping their cards very close to their chests to keep the world guessing.
Related links:
Compare and contrast – FT Alphaville
China’s fake recovery redux, or who’s laughing now? – FT Alphaville
BNY Mellon’s fx team: Ultimately, buy gold - FT Alphaville