Foreign exchange reserves are holdings of foreign currencies held by central banks. They are usually in the form of bills and bonds of foreign states, which allow these reserves to bear interest. They are used by monetary authorities to regulate interest rates. The total has increased fivefold between 1995 and 2009, from $1,390 billion to $ 7,516 billion.
Since 2000, this increase is mainly due to Asian central banks, whose reserves have increased from $1,000 billion to $2,500 billion over the same period. These reserves, depending on the countries and times, serve for different objectives. Basically, their primary purpose is to maintain market confidence toward the national currency and show that the country has the resources to withstand a financial shock.
Nevertheless, the current evolution of reserves in Asian countries has very little to do with this logic. The primary example from Asia is Japan, which since starting its battle against deflation and the bursting of the housing and financial bubbles in the early 1990s, has raised its foreign exchange reserves to levels never seen before. The purchase of foreign exchange reserves in US dollars has as its main aim maintaining the Japanese yen low against the US dollar, which due to Japan's export-oriented economy, sustains its economic activity. In general, at the present moment, Asian economies, like the Japanese economy, are focusing on exports.
Statistics from the IMF show that the proportion of US dollar held in global foreign exchange reserves fell in the third quarter of 2009, while the overall amount of reserves held by central banks increased to more than $7,500 billion (€5,230 billion).
The US dollar proportion of claims held as a total of allocated reserves amounted to 61.65 per cent at the end of September 2009 ($4.434 billion), against 64.20 per cent as at the end of December 2008. The claims held in euro, on the other hand, increased to 27.75 per cent from 26.42 per cent, while the claims held in Japanese yen increased to 3.23 per cent from 3.13 per cent over the same period.
However, it was the share of reserves denominated in "other currencies", that is, other than the US dollar, euro, yen, British pound and Swiss franc, which have witnessed the most significant advance-from 2.07 per cent to 2.90 per cent over the same period. Although details of the share of the reserves held in "other currencies" are not published, it is likely the share of Canadian dollar is up sharply, as the central bank of Russia, last year increased significantly the amount of Canadian dollars in its reserves.
These statistics cover the foreign currency holdings of 140 countries holding 59 per cent of $7,516 billion worth of global reserves. However, they exclude China, which has the largest amount of foreign exchange reserves, which amounts to $2,273 billion as of September 30, 2009; more than 30 per cent of total global reserves. China does not disclose any information on which currencies its reserves are denominated in, but experts believe that most of it is held in US dollars.
Foreign exchange reserves may have a significant impact on currency rates as shown in the second chart above (EUR/USD vs. Ratio of claims in USD to EUR); the euro against the US dollar is inversely related to the ratio of claims in US dollar vs euro. The ratio of claims in US dollars vs. euro increased from 1995 to 2001, from 2.19 to 3.73 resulting in a drop in EUR/USD from 1.2770 to 0.8904. Since 2001, the opposite occurred; central banks have reduced their shares in US dollars and increased their shares in euros, as the ratio decreased from 3.73 to 2.22, and the EUR/USD appreciated during this period from 0.8904 to 1.4316.
Upcoming FX key events
ECB interest rate decision today followed by the ECB President's news conference. Key economic data: German CPI, US Retail Sales (today), eurozone CPI, US CPI and Michigan Consumer Sentiment (tomorrow).
FX technical key points
EUR/USD is bearish, target 1.3560, key reversal point 1.4800
USD/JPY is bullish, target 98, key reversal point 85
GBP/USD is bearish, target 1.5050, key reversal point 1.7000
USD/CHF is bullish, target 1.1000, key reversal point 0.9950
AUD/USD is bearish, target 0.7800, key reversal point 0.9400
NZDUSD is bearish, target 0.6200, key reversal point 0.7650
Mr Longchamp is head of trading at RTFX Ltd.
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