There is probably truth to the rumours of the Chinese monetary authorities’ intention to diversify currency reserves to the detriment of the US dollar, but the scope of the change should not be overestimated......
This is because China’s margin for action is limited. The increase in emerging countries’ currency reserves will translate into positive net demand for US and European government bonds in 2018.
In the past few days, some commotion was stirred up by a Bloomberg News report according to which the Chinese authorities in charge of investment in currency reserves have recommended reducing the weight of the US dollar, by slowing down or ending UST purchases. While the issue of a directive to this end has not been denied, SAFE (the authority which manages currency reserves) has commented that its choices are prompted by market considerations.
As at October 2017, there was no real indication of such directives having been aggressively applied. When comparing the trend of currency reserves with US statistics on UST holdings by country, between January and October reserves grew by around 106 billion dollars, whereas USTs held by Chinese operators increased by 130.8 billion. It is also true that the Chinese authorities manage such a large a stock of reserves that they are well aware of their investment choices not being neutral in terms of their market impact, as also proven by the short-term reaction to the release of the Bloomberg news item. This limits their freedom of action, as overly brutal re-composition policies could lead to perverse effects on the value of the reserve stock through the movements of the dollar and of security prices.
Furthermore, as negative as their view on the market outlook may be, there is no question that currency reserves amounting to around 3,200 billion dollars will include a strong component in US dollars: there are few alternatives, considering that both the ECB and the BoJ are still aggressively purchasing government bonds, and that other countries have markets that are in no way comparable in terms of size and liquidity to the dollar and the euro, two currencies that are destined to retain a dominant role in the international monetary system in the coming years.
Nor would re-composition to the advantage of gold reserves provide a solution. China effectively seems to have tested this option between 2015 and 2016, when the value of gold reserves increased from around 60 billion to 79 billion dollars. However, most of the increase reflected the fluctuations of the price of gold and, in any case, the value of gold reserves is actually lower today than it was in mid-2016 (stable net of price changes). Furthermore, the current level of 76 billion accounts for a risible share of the overall currency reserve stock, and there is no reason to think that its role will become more significant – also considering that gold reserves are not entirely fungible, when compared to currency reserves proper.
Therefore, in an environment in which the reserve stock is increasing, and the renminbi is appreciating, as was the case in 2017, UST purchases are unlikely to be fully discontinued. The re-composition may possibly accelerate in a reserve stock reduction phase tied to a new wave of capital outflows (when it could also be instrumental in curbing downward pressures on the renminbi), but the process would be very slow in any case. Possible negative repercussions on the balance of demand/supply on the Treasury market will be further mitigated by the positive trend of the stock of currency reserves in the other emerging countries, already evident in 2017 and expected to continue in 2018, at an almost unchanged pace of 200-250 billion dollars. This trend is fuelled less by the positive current account balance, which could in fact shrink, than it is by improving capital flows, both foreign and owned by residents.
The financial analysts who prepared this report, and whose names and roles appear on the first page, certify that: (1) The views expressed on companies mentioned herein accurately reflect independent, fair and balanced personal views; (2) No direct or indirect compensation has been or will be received in exchange for any views expressed. Specific disclosures: The analysts who prepared this report do not receive bonuses, salaries, or any other form of compensation that is based upon specific investment banking transactions.
This research has been prepared by Intesa Sanpaolo S.p.A. and distributed by Banca IMI S.p.A. Milan, Banca IMI SpA-London Branch (a member of the London Stock Exchange) and Banca IMI Securities Corp (a member of the NYSE and NASD). Intesa Sanpaolo S.p.A. accepts full responsibility for the contents of this report. Please also note that Intesa Sanpaolo S.p.A. reserves the right to issue this document to its own clients. Banca IMI S.p.A. and Intesa Sanpaolo S.p.A. are both part of the Gruppo Intesa Sanpaolo. Intesa Sanpaolo S.p.A. and Banca IMI S.p.A. are both authorised by the Banca d'Italia, are both regulated by the Financial Services Authority in the conduct of designated investment business in the UK and by the SEC for the conduct of US business.
Opinions and estimates in this research are as at the date of this material and are subject to change without notice to the recipient. Information and opinions have been obtained from sources believed to be reliable, but no representation or warranty is made as to their accuracy or correctness. Past performance is not a guarantee of future results. The investments and strategies discussed in this research may not be suitable for all investors. If you are in any doubt you should consult your investment advisor.
This report has been prepared solely for information purposes and is not intended as an offer or solicitation with respect to the purchase or sale of any financial products. It should not be regarded as a substitute for the exercise of the recipient’s own judgement.
No Intesa Sanpaolo S.p.A. or Banca IMI S.p.A. entities accept any liability whatsoever for any direct, consequential or indirect loss arising from any use of material contained in this report.
This document may only be reproduced or published together with the name of Intesa Sanpaolo S.p.A. and Banca IMI S.p.A.. Intesa Sanpaolo S.p.A. and Banca IMI S.p.A. have in place a Joint Conflicts Management Policy for managing effectively the conflicts of interest which might affect the impartiality of all investment research which is held out, or where it is reasonable for the user to rely on the research, as being an impartial assessment of the value or prospects of its subject matter. A copy of this Policy is available to the recipient of this research upon making a written request to the Compliance Officer, Intesa Sanpaolo S.p.A., 90 Queen Street, London EC4N 1SA.
Intesa Sanpaolo S.p.A. has formalised a set of principles and procedures for dealing with conflicts of interest (“Research Policy”). The Research Policy is clearly explained in the relevant section of Banca IMI’s web site (www.bancaimi.com).
Member companies of the Intesa Sanpaolo Group, or their directors and/or representatives and/or employees and/or members of their households, may have a long or short position in any securities mentioned at any time, and may make a purchase and/or sale, or offer to make a purchase and/or sale, of any of the securities from time to time in the open market or otherwise. Intesa Sanpaolo S.p.A. issues and circulates research to Qualified Institutional Investors in the USA only through Banca IMI Securities Corp., 245 Park Avenue, 35th floor, 10167 New York, NY,USA, Tel: (1) 212 326 1230. Residents in Italy: This document is intended for distribution only to professional investors as defined in art.31, Consob Regulation no. 11522 of 1.07.1998 either as a printed document and/or in electronic form. Person and residents in the UK: This document is not for distribution in the United Kingdom to persons who would be defined as private customers under rules of the FSA.
US persons: This document is intended for distribution in the United States only to Qualified Institutional Investors as defined in Rule 144a of the Securities Act of 1933. US Customers wishing to effect a transaction should do so only by contacting a representative at Banca IMI Securities Corp. in the US (see contact details above).
Trading Ideas are based on the market’s expectations, investors’ positioning and technical, quantitative or qualitative aspects. They take into account the key macro and market events and to what extent they have already been discounted in yields and/or market spreads. They are also based on events which are expected to affect the market trend in terms of yields and/or spreads in the short-medium term. The Trading Ideas may refer to both cash and derivative instruments and indicate a precise target or yield range or a yield spread between different market curves or different maturities on the same curve. The relative valuations may be in terms of yield, asset swap spreads or benchmark spreads.
Coverage Policy And Frequency Of Research Reports
Intesa Sanpaolo S.p.A. trading ideas are made in both a very short time horizon (the current day or subsequent days) or in a horizon ranging from one week to three months, in conjunction with any exceptional event that affects the issuer’s operations. In the case of a short note, we advise investors to refer to the most recent report published by Intesa Sanpaolo S.p.A’s Research Department for a full analysis of valuation methodology, earnings assumptions and risks. Research is available on IMI’s web site (www.bancaimi.com) or by contacting your sales representative.