On Friday, the IMF released a report that demonstrated that global central banks continue to pare reserves held in USD. The report stated that (as of 12/31) global central banks held 61.7% of their reserves in greenbacks. This is the lowest since 2013 (demonstrated in the shaded area of the chart). At the same time, the report showed that the euro, yen and yuan all gained ground.
Despite this decline, the dollar index (blue line) has remained resilient in part to the fact that global central banks continue to flood the market with liquidity which has kept interest rates outside the U.S. much lower. The purple line is the spread between the U.S. 10-year bond and the Germain 10 Year Bund. This wide spread has help demand for dollars stay relatively strong.
The dollar has been the reserve currency of choice for most of the world’s central banks post WWII, given the depth and stability of U.S. bond markets. The status comes with several notable advantages: demand for dollar-denominated assets has helped the U.S. keep a lid on funding costs and run budget deficits, as trading partners park their reserves in U.S. government bonds. A continued decline in U.S. denominated reserves could cause exchange rates to weaken, funding costs (i.e., interest rates) to rise which would make it more costly on the economy to maintain high budget deficits.
Stay tuned as this could become a newsworthy topic as the year progresses and the U.S. issues more debt in 2H than in prior years.
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