Another Twist on Reserve Diversification

We have identified the interest rate differential theme as the major driver in the foreign exchange market. Another theme has also impacted the foreign exchange market is the diversification of new reserve accumulation. The focus here is primarily Asia. A number of central bank Asia are believed have intervened in the recent period. They buy dollars and sell their own currency. Some of the dollars are used to buy Treasuries and Agencies. This is evident in the Fed's custody holdings for foreign central banks, which rose nearly as much in Q3 ($132 bln) as in Q1 and Q2 put together. Already in the first half of October, custody holdings have risen about $38 bln. Some of the dollars are sold for other currencies and this helps keep the general allocation largely stable. New custody holding data will be released later today.

Although a couple of Asian central banks are believed to have intervened earlier today, the reserve diversification story is not in Asia but in Switzerland. Reserve figures from the SNB reveal that in Q2 it was diversifying its reserves away from the euro that is bought as part of its QE. Euro holdings fell to 91 bln euros (~$128 bln) from 120.5 bln euros in Q1. Dollar holdings increased by almost $10 bln to $54.6 bln. The SNB also increased its sterling holdings slightly (a little less than GBP 1bln) and yen holdings (a little more than JPY1.07 trillion). Of note the SNB also increased its Canadian dollar holdings in reserves from CAD3.8 bln to CAD9.0. bln.

Overall SNB reserves eased to CHF216.7 bln at the end of Q3 from CHF226.7 bln at the end of Q2. This overall decline likely reflects the valuation adjustment. In Q3, the euro appreciated 1.6% against the Swiss franc, but sterling fell 4.1%, the Canadian dollar fell by 5.7% and the US dollar lost almost 9% against the Swiss franc.