CORPORATE FINANCING NEWS: FOREIGN EXCHANGE
By Denise Bedell
Contrary to some analysts' expectations, developing
countries continue to view the US dollar as the reserve currency
of choice, as evidenced by newly allocated official reserves of
developing countries-even in the face of expectations of ongoing
quantitative easing by the US.
Rather than unloading US dollars in the third quarter, reserve
managers grew US dollar holdings, according to the latest IMF
report on the Currency Composition of Official Foreign Exchange
US dollar purchases rose to SDR27.1 billion (SDR being special
drawing rights, the official unit of account for the IMF and
currently equivalent to about $1.54) in the third quarter of 2010
from SDR19.3 billion in the second quarter. The euro, in contrast,
saw the big buying of the first and second quarters reversed in the
third quarter, with net sales of SDR11.5 billion.
Jeffrey Young, managing director and head of North American foreign
exchange research at Barclays Capital, says that these movements
are consistent with longer-term behavior. "Developing countries
tend to "lean against the wind," he notes, buying more dollars when
it is weak and less when it is strong.
Movements during and after the financial crisis provide insight
into which currencies are considered good reserve currencies, says
Young. During the worst of the crisis, emerging market countries
were unloading US dollars at a high rate-selling off SDR131.5
billion during the fourth quarter of 2008 and first quarter of
2009, according to the Cofer figures. "Paradoxically, the selling
of US dollars demonstrates its value as a reserve currency," notes
Young. "If nothing else, countries need to be able to use reserves
on a rainy day, and the US dollar was the only currency able to
fulfill this role."
In the wake of the crisis, developing countries' purchases of US
dollars and euros have returned to rates more in line with historic
averages. The return to a normal reserve currency purchase pattern
shows that the crisis did not have a long-term impact on reserve
Rates to Rise in Emerging Markets
Many emerging market and dollar bloc countries are moving into
monetary tightening cycles, according to analysts at Deutsche Bank,
and will likely see interest rates rise further by midyear. In
developing countries, speedy economic recovery and mounting
inflation have triggered monetary tightening, while in dollar bloc
countries the same result was triggered by the strong rise in
commodities and growth in emerging markets. A number of countries
have already begun to raise rates-some as much as 200 basis
points-and will continue to do so as the year progresses.
The US and Europe will follow suit later in the year, Deutsche Bank
analysts say in a report: "We expect the European Central Bank to
begin raising rates after mid-2011 as inflation moves toward the
desired level in the euro area," they venture. "Our US economics
team has the Fed ending its QE2 [second round of quantitative
easing] in mid-2011 and beginning to nudge rates higher by the end
of the year, as the labor market improves more sustainably and
inflation moves higher."
Dollar Gains on Manufacturing Figures
The Institute for Supply Management (
) January 2011 new orders index showed US manufacturers are still
performing well, posting the 18th consecutive month of growth. The
only areas of contraction seen in the index were in customer
inventories and order backlogs. The chairman of the ISM, Norbert
Ore, says: "We saw a significant recovery for much of the US
manufacturing sector in 2010. The recovery centered on strength in
autos, metals, food, machinery, computers and electronics, while
those industries tied primarily to housing continue to struggle.
Additionally, manufacturers that export have benefited from both
global demand and the weaker dollar."
Michael Woolfolk, managing director at BNY Mellon Global Markets,
says: "The US manufacturing sector continues to show clear and
consistent signs of growth and expansion, with steady expansion in
employment. With the rally in equities showing no signs of letting
up, January seasonals should boost both stock market valuations and
investor confidence. As risk appetite continues to improve, US
dollar selling is likely to resume."