DOLLAR WATCHERS LOOK TO IMF / THE WALL STREET JOURNAL

Foreign Exchange

Dollar Watchers Look to IMF

Data on central banks’ holdings of greenbacks are expected to fuel the rally

By Ira Iosebashvili And Min Zeng    

March 29, 2015 5:06 p.m. ET
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The dollar is expected to get a lift from IMF figures detailing central banks’ holdings of greenbacks. Photo: MARK WILSON/GETTY IMAGES

A roaring dollar rally could get a boost this coming week with the release of data that many investors expect to provide fresh evidence that central banks are embracing the greenback.

International Monetary Fund figures on global foreign-exchange holdings for the fourth quarter of 2014 are likely to show central banks piling into the dollar and lightening up on the euro, traders and analysts said. The IMF data, known as Cofer for Currency Composition of Official Foreign Exchange Reserves, are expected to be released Tuesday morning.

With nearly $12 trillion at their command, central banks are by far the biggest players in the foreign-exchange market, and their actions accordingly are closely watched by investors. Though the data are historical rather than forward-looking, fresh gains would bolster expectations that the dollar’s sharpest rally in decades has more room to run as the Federal Reserve prepares to raise interest rates as soon as June.

In the past eight months, the dollar has risen more rapidly than at any time in the past 40 years when compared with the currencies of its major trading partners, according to data from Citigroup Inc. The dollar has risen 28% against the euro since May and the WSJ Dollar Index is up 19% over the past year.

 “The euro no longer looks to be an attractive alternative to the persistent reserve currency, which is the dollar,’’ said Robert Sinche, global strategist at Amherst Pierpont Securities.

The third quarter’s figures showed a vast outflow of central-bank funds from euros and into the dollar, a reversal after a long period in which official holdings of the U.S. currency tumbled.        

                 
The IMF’s latest data release, for the third quarter of 2014, showed euros accounted for 22.6% of central banks’ reserves, a decline of 1.5 percentage points and the largest fall since 2004. It also showed a 1.6 percentage-point increase in allocations to the dollar, also the largest in more than a decade. The data is released on the last business day of every quarter and shows central-bank holdings going two quarters back.

The shift out of the euro came after the European Central Bank lowered the interest rate on deposits held with it to below zero last June for the first time in history, as it tried to head off a recession. The ECB’s move sparked an exodus of cash out of the euro, as central banks were now forced to pay for the privilege of owning euros.

Much of that cash found its way into assets denominated in dollars, attracted by an expected rate increase that would make the currency more attractive for investors seeking yield. Most investors anticipate the Fed will raise rates this year for the first time in almost a decade.

Some analysts and money managers said they believe interest in holding euros among central banks continued to weaken during the fourth quarter of last year and during the first quarter of 2015, a shift they believe accentuated the euro’s plunge. On March 9, the ECB began large-scale purchases of bonds, a tactic known as quantitative easing.

By printing money to pay banks selling the bonds, the central bank drives down the currency’s value in hopes of fostering lending and spurring economic activity.

Mr. Jen, a former economist at the IMF and the Fed, said that while safety and liquidity trump returns for central banks when they allocate their foreign-exchange reserves, it doesn’t make sense for reserve managers to hold negative-yield assets because it is punitive.

Negative-yield bonds have been the fastest-growing asset in the region over the past six months.

Now, more than a quarter of eurozone government bonds trade with negative yields, according to some analysts.

A buyer of negative-yield bonds pays a higher price than the bond’s par value.

Mr. Jen says he expects the euro to fall to $1 as soon as May or June. Others, however, are alarmed by the dollar’s sharp rally. In a note issued this month by HSBC Holdings PLC, analysts said that the dollar’s bull run “is nearing its end,” given how much the currency has already rallied. While most banks predict the euro will decline against the dollar next year, HSBC sees the currency rising to $1.10, versus $1.0890 Friday.

“The drama offered by policy divergence has already run its course,” analysts at the bank said in a note to investors. “Valuations show the dollar is nearly the world’s most overvalued currency.”