How do central banks rebalance their currency shares?
The most significant example of ongoing intervention in FX has been from the Swiss National Bank (SNB) as it tries to stop the franc from rising too rapidly against the euro. How do other central banks rebalance their currency shares?
The Swiss National Bank (SNB) is trying to stop the franc from rising too rapidly against the euro. Photo: Thomas J. Jordan is Chairman of the Governing Board of the Swiss National Bank (SNB).
Currencies, especially those in developed markets, have been very stable for some time. For instance, the DXY measure of the dollar against other major currencies has been trapped in a 5% trading range for much of the past year. This may be because the pandemic has been a symmetric shock and hence not one that’s given any particular country or currency an advantage. It might be because the Fed has been better at supplying dollar liquidity internationally, which helps stem volatility surges. But there’s also another issue, again to do with central banks, that could be a factor as well.
Mr. Steve Barrow, Head of Standard Bank G10 Strategy said that in developed currencies, the most significant examples of ongoing intervention in FX have been from the Swiss National Bank (SNB) as it tries to stop the franc from rising too rapidly against the euro. Its hefty intervention has seen reserves rise from practically zero in 2009 to nearly USD1tr today and has not just helped stem the fall in euro/Swiss; it has also had reverberations for other currencies such as the dollar. This is because the SNB maintains stable proportions of its reserves for a number of currencies, mainly euros and dollars, which both had a share of 38% of FX reserves at the end of Q2. Hence, when the SNB buys euros to stop the franc rising too far it converts some of these to dollars, and a number of other currencies, to maintain the desired proportions.
“Beyond this, as the value of these currencies changes over time we’d expect the SNB to buy or sell currencies to maintain the desired ratios. For instance, if the dollar falls heavily and its proportion of total reserves falls too far, we’d expect the SNB to sell other currencies and buy more dollars. This action of rebalancing reserves clearly acts as a stabilising force as more dollar weakness brings about more dollar purchases and vice versa. But the FX market is very big at over USD 6 trillion per day and, while large, Swiss reserves can’t be expected to stabilise the dollar. But what if other central banks do roughly the same. Namely that they judge reserve holding according to a desired portfolio and act to rebalance this portfolio when currencies move. With global reserves standing at over USD12 trillion, this might just be sufficient to be quite a stabilising force for the FX market. Evidence suggests that not all central banks are as dogmatic about rebalancing as the SNB. That’s not surprising. But if we look at some recent research, we see evidence of at least partial rebalancing, especially among those central banks that have a high level of reserves like the SNB”, Mr. Steve Barrow said.
The FX market is used to the concept of private sector investors rebalancing at month end or quarter end. But this rebalancing is usually because equity or bond shares have shifted from desired ratios. So, if US stocks underperform in the quarter, asset managers buy more and hence buy dollars to facilitate the trade. But this is not necessarily stabilising FX because the dollar could have risen during the quarter and then, at quarter end, asset managers buy more and potentially destabilise by making a strong dollar even stronger (or vice versa). “With central banks, we are talking about rebalancing because of FX movement; not the movement of any underlying assets”, Mr. Steve Barrow stressed.
While it seems reasonable to conclude that central banks could stabilise the FX market in this way, even if inadvertently, are such flows sufficient to have a bearing on the huge FX market. The report of the Standard Bank pointed out that a 10% fall in the dollar could create an annual demand of USD300bn given the size of global reserves and assuming central banks want to keep around 60% of reserves in dollars. That’s not a small amount; about half the annual current account deficit. It certainly makes it an issue worth thinking about now that global reserves have risen to such a huge size.