Capital Gold Group Report: Central Banks Trim Euro, Dollar Holdings

By Bradley Davis

JUNE 30, 2010, 5:24 P.M. ET

Central banks pared their euro holdings in the first quarter of the year and likely cut them even further in the second quarter as the euro-zone sovereign-debt crisis worsened.

The euro's share of global central-bank holdings slipped slightly from the last quarter of 2009, according to data published Wednesday by the International Monetary Fund, indicating the fiscal woes of European nations started to have a small impact on these large investors.

"The European debt crisis is going to have [a] major impact" on the second quarter's data, said Win Thin, senior currency strategist at Brown Brothers Harriman in New York.

As the euro-zone has grappled with the debt crisis, the value of the common currency has dropped 15% versus the dollar since the start of 2010. The sharpest drop, though—to the $1.1876 registered in early June—wasn't seen until the second quarter.

The dollar, whose share of global reserve holdings also slipped, should gain at the euro's expense, Mr. Thin said.

Total world-wide foreign-exchange holdings measured $8.295 trillion in the first quarter, up from a revised $8.165 trillion in the fourth quarter, according to preliminary numbers from the IMF. In the first quarter of 2009, total foreign-exchange holdings stood at $7.164 trillion. According to the IMF, 139 countries contributed to the data. The data detailing holdings of individual currencies don't include China's $2.4 trillion in reserves.

Central banks form the backbone of the currencies markets. Their slow and steady shifts out of the dollars they generally receive from trade or commodities exports, and into other currencies, play a big role in determining exchange rates.

Because they invest for the long term, they seek stable, robust currencies and typically tweak holdings at a glacial pace

As the euro zone continues to struggle with budget deficits and the U.S. faces fiscal problems of its own, central banks likely will be searching for other currencies liquid enough in which to park reserve holdings, said Alan Ruskin, global head of currency strategy for RBS Securities in Stamford, Conn.

This likely explains the increase in the data's "other" category, which includes the Canadian and Australian dollars and the Norwegian krone. This category of currencies closely aligned with global growth registered the strongest gains in reserve allocations, jumping to 3.65% in the first quarter of 2010 from 3.12% in the fourth quarter of 2009.

"People are looking for the next set of liquid markets where the fundamentals are more supportive and where you're not dealing with the same degree of sovereign concern," Mr. Ruskin said.

The first-quarter data don't show a rush to diversify out of the euro. The euro's share of reserves declined slightly, with a 27.19% share in the first quarter, from 27.3% in the fourth quarter. Its first-quarter share remains higher than the 26.4% from the fourth quarter of 2008, when the world financial crisis roiled currency markets.

The U.S. dollar accounted for 61.54% of global allocated reserve holdings, a small decrease from its 62.14% share in the fourth quarter.

The data break out only 55.6% of total global reserve holdings into specific currencies, Mr. Thin said, with the remaining 44.4% "unallocated," a category that includes China, the largest holder of reserves, thought to account for about 30% of total global holdings.

Global allocated reserves stood at $4.61 trillion in the first quarter, up from $4.56 trillion in the fourth quarter. The amount of allocated reserves in dollars stood at $2.838 trillion, an increase from $2.836 trillion in the fourth quarter, the IMF data showed.

Reserves held in the British pound increased to 4.34% in the first quarter from 4.28% in the fourth quarter; the amount held in Japanese yen increased to 3.14% from 3.01%. The Swiss franc claimed 0.12% of global reserves from 0.1%.

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