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Get ready for EM reserve accumulation

The Emerging View

06 February 2018

Emerging Markets (EM) currencies are rallying against the Dollar. EM central banks will soon be forced to intervene, so central bank reserves will go up. Based on eighteen years of data we find that EM reserves increase four times faster than currencies during EM currency bull markets, but decline by less than half the speed of currencies during bear markets in EM FX. A further 10% appreciation in EM currencies – which we think is extremely feasible – could increase the level of FX reserves for the eighteen EM countries in the GBI EM GD index from USD 2.2trn (19% of the world total) to USD 3.1trn. On the other hand, we would only expect EM reserves to decline to about USD 2.1trn if EM currencies give up 10%. These estimates may be affected by numerous country specific effects, but we do not believe that the most important of these – the reaction function of EM central banks to changes in FX – will change materially. The implication for EM central banks and other institutional investors is clear: begin to diversify reserves now, because (a) EM reserves will rise going forward and (b) there will be improving liquidity and better returns in non-Dollar currency markets, including EM FX.

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