[cppene]

While the markets have debated the demise of the USD and private investors being heavily short US units, central banks seemed to have used this opportunity to buy USD’s. Over the course of the past year foreign central banks increased its USD holdings with the FED by USD605bln – at a time when global currency reserves increased by only USD35bln. Changes in custody holdings and currency reserves were correlated, however custody holdings are increasing at their fastest rate since 1982, but global currency reserves have been minor over the course of the past year. Custody holdings rising faster than currency reserves suggest that central banks might have increased the weighting of the USD in their currency reserves. (Even so some of the increase might be due of CB’s reducing deposit holding with commercial banks). This finding might be a surprise given recent noise concerning the introduction of new currency reserve currencies. Still remembered was the PBoC analysis on currency reserves claiming SDR taking over from the USD as main reserve currency.

Anyhow, practical behaviour of central banks concerning the management of its currency reserves seems to be different from noises made in public. But this leaves the question why central banks have piled into the USD at this point. China comes back into focus. Over the past few months the countries currency reserves have increased at a faster pace when compared to its current account and FDI inflows as hot money has entered the country. These funds have been moved into China either to invest in the local asset rally or simply a bet on early appreciation of the RMB. Things were very similar late 2004 when the USD declined and investors place bets on RMB appreciation. Asian inflows tend to be USD funded suggesting that there is a substantial USD short position counter balancing the hot money inflow into China. Hence, the PBoC might just take the opposite position limiting the negative effects should the hot money inflows turn into a sudden outflow.