Are Central Banks Losing Their Grip on the Dollar?

Central banks, managing trillions of dollars in foreign exchange reserves, have long been considered key players in maintaining the dollar's status as a global safe-haven currency. However, a recent report by Standard Chartered raises questions about this assumption.

Divergent Strategies

The bank found that reserve managers tend to buy when the dollar is weak and sell when it is strong. This behavior contrasts with that of private sector investors, who often drive dollar exchange rate movements.

Impact of Geopolitical Factors

The current year has seen challenges for the dollar, including trade and security disputes between the United States and its allies, as well as President Trump's repeated criticisms of the Federal Reserve. These factors have contributed to a 9% decline in the dollar's value.

Data Analysis

Standard Chartered's analysis showed that over the past 20 quarters, the level of official US dollar reserves has moved in the opposite direction to the dollar index, which tracks the dollar's value against a basket of currencies. For instance, the dollar fell by 6.6% in the second quarter, but official dollar reserves increased by approximately $50 billion.

Private Sector vs. Central Banks

Steve Englander, global head of G10 foreign exchange research at Standard Chartered, suggests that private sector buying is driving the dollar, while central banks are reacting passively. He adds that central banks may be balancing their own currency's competitiveness with portfolio considerations.

Diminishing Influence of Central Banks?

Englander argues that if the private sector is a net seller of the dollar, central banks are unlikely to sell as well, potentially putting further downward pressure on the currency. Conversely, when the private sector buys dollars, central banks take the opportunity to reduce their exposure, while avoiding sales that could exacerbate competitiveness shocks.

Capital Flows

Englander posits that the size of directed capital flows from private sector investors may have grown relative to central banks, meaning their impact may outweigh that of central banks.

Conclusion

Despite the historical role of central banks in supporting the dollar, the private sector appears to be becoming a more influential player in determining the currency's value. This doesn't mean central banks have no impact, but their strategies may be more complex and nuanced than simply maintaining the dollar's value.