Central banks

Central banks seek liquidity and safety, shifting away from government bonds and traditional reserve currencies
Central banks have undertaken a significant rotation of their low risk asset portfolios from government bonds to deposits; allocations to traditional reserve currencies of the dollar, euro and sterling have reduced in favour of greater diversification, including the renminbi, while a small number of banks have made large gold purchases.

Central banks

We conclude the report with the observation that central banks are moving to towards liquidity and perceived safety, shifting away from government bonds and traditional reserve currencies (Figure 10). After a long period of comparatively loose monetary policy, banks became increasingly pro-cyclical in their investment strategy – a shift often initially facilitated through portfolio tranching before moving to more holistic approaches.

However, a more uncertain environment around the direction of travel for Federal Reserve policy has seen a significant rotation from government bonds to deposits, both commercial deposits and deposits with other central banks. European banks in particular have been active to avoid negative yields in European government bonds.

Figure 10. Allocation of reserves portfolio, Central banks only (% AUM)

Figure 10. Allocation of reserves portfolio, Central banks only (% AUM) Figure 10. Allocation of reserves portfolio, Central banks only (% AUM)

Sample size: 2016: 15; 2017: 33; 2018: 55; 2019: 36.

Gold has seen some return to favour despite adding volatility to portfolios (Figure 11). While average gold holdings remain modest across respondents at around 4%, a small number of central banks made large increases to gold in their reserve portfolios. Increases by these institutions are a response to concerns about global instability, political risk, and the US fiscal position. Gold has become an alternative for central banks seeking a “safe-haven” asset which also offers diversification away from the USD. For some central banks, historically high US debt-to-GDP levels create some doubts about the assumed risk-free nature of US government paper and the status of the US Dollar as the world’s reserve currency.

Figure 11. Changes to gold reserves, last 3 years and next year, Central banks only (% citations)

Figure 11. Changes to gold reserves, last 3 years and next year, Central banks only (% citations) Figure 11. Changes to gold reserves, last 3 years and next year, Central banks only (% citations)

Change over last 3 years sample size: 54; Expected change over next year sample size: 57.

On the flipside gold brings additional issues, including price volatility, lack of yield, storage costs, and perception management when selling. Despite being highly liquid, gold can prove difficult to sell in volume in practice due to the domestic political reactions and the possibility of a lasting negative legacy of selling gold ‘at the wrong time’ (Figure 12).

Figure 12. Level of agreement with statements on gold holdings, Central banks only (% citations)

Figure 12. Level of agreement with statements on gold holdings, Central banks only (% citations) Figure 12. Level of agreement with statements on gold holdings, Central banks only (% citations)

Sample size: 27.

Meanwhile, strengthened by its the inclusion of the RMB in the Special Drawing Rights basket, the growing importance of China as a trading partner, and structural changes to the domestic bond market, there has been an increase in the central bank holdings of Renminbi. The Renminbi has been the main beneficiary of the decline in USD holdings, increasing from a negligible proportion of world reserves in 2016 to 1.9% at the end of 2018. During this period, it overtook the AUD and CAD to become the world’s fifth most important reserve currency.1

Source: IMF COFERS, Data for Q4 2017, 2018, accessed 31 May 2019.