One by-product of the massive capital reallocation to emerging market economies, highlighted by RGE for some time, has been a sharp acceleration in foreign exchange reserves accumulation. Central banks, particularly in emerging market economies, have been adding reserves at the pace of an average US$250 billion per quarter since Q2 2009 as they sought to reduce the appreciation and volatility of their currencies. IMF data reported that the global reserve stock exceeded US$7.5 trillion in Q3 2009, well higher than aggregate pre-recession levels. October and November data suggest that Q4 looks to be more of the same story. At this pace (US$1 trillion annualized), reserve accumulation in excess of the deficits of the U.S. and other “overspenders”.
But is reserve accumulation now taking a breather?
There are signs that the pace of inflows slowed markedly at year end, especially in Asia. Asian reserve growth cooled, led by countries like Taiwan and Korea. The Hong Kong Monetary Authority was able to ease up on its intervention as the HKD settled near its midpoint of its fx band for much of December. Outside of Asia, Russia’s reserves slipped to less than US$440 billion as Russia drew on its reserves fund and the fall in the oil price reduced interest in ruble-denominated assets.
Of early reporting countries, only Mexico, flush from cashing out its oil hedges, bucked the trend, adding US$9 billion adjusting for valuation. While we should hold considerations around global trends until China releases its reserves data in mid January, there could be a pause.
Assuming there is a slowdown, what caused it? Was it year-end portfolio rebalancing? Premature pricing-in of Fed hikes?
Are the capital controls imposed by the likes of South Korea and Brazil discouraging investment?
Is the tapering off of the IPO pipeline to blame?
Whatever the cause, the pause could be short lived. As RGE argues in our recent analysis around currency performance in 2010 and carry trade strategy, significant reversal of 2009’s hot money inflows seems unlikely – especially given the persistence of loose monetary conditions in the advanced world and macroeconomic outperformance of EMs.