Even if you don’t trade the yuan directly, you probably want to keep an eye on Chinese foreign exchange reserves. Not just because China is the second largest economy, but also because they are the largest holder of reserves in the world. They routinely intervene in the markets in ways that affect currencies.
Let’s get some perspective on scale.
China has consistently maintained foreign reserves at over $3.0T for several years. In comparison, the Federal Reserve at the end of May had just $41.4B in foreign holdings. The ECB in the same period had $70.7B.
Those are the world’s largest central banks, and Chinese holdings are nearly thirty times more than both combined.
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That’s a Lot of Money
While there is a monthly report of the total holdings, the exact composition is not known. It’s a state secret!
So, analysts are forced to figure out how much of each currency China has. The estimates vary, but it seems that around two-thirds of the holdings are in USD-denominated assets. The remaining third are in other currencies, such as the euro, pound, and yen.
Note that so far the name of the central bank – the People’s Bank of China – hasn’t come up. That’s because although these assets are held by the PBOC, unlike other countries, the Chinese government influences the policy of the central bank.
Therefore, interventions in the markets are not just to maintain the stability of the currency, but to also support strategic and even political objectives.
Figuring Things Out
The combination of these factors makes projecting future actions by Chinese monetary regulators and their effects on the market more difficult.
This is a problem, because, given the size of their holdings and their propensity to use their size to get what they want, they can and do influence markets.
Presumably, Chinese interest is in influencing the value of their own currency. But to do so, they often influence other currencies that it trades with. In the latter part of last year, the PBOC was selling over $100B in assets a month. This is far more than what the Fed was doing as part of its balance sheet normalization process.
What Does China Want
Despite the political rhetoric from the US routinely threatening to label China a currency manipulator, the reality on the ground is, as one might expect, more complicated.
China has been in a decades-long process of slowly liberalizing its currency so it becomes free float. This means the PBOC both de jure and de facto control the value of the currency through several means. These include selling or buying foreign currency.
The conventional wisdom is that China would prefer a lower exchange rate to support exports. However, in the wake of the trade war with the US, their currency took a significant hit. Rather than celebrate it, the PBOC spent a significant amount of their holdings trying to support the yuan.
So, currency stability seems to be a bigger concern.
What’s Coming up?
Over the weekend we get the latest report of the PBOC’s holdings in foreign currency. This figure usually does not move the markets directly, but it is a key component of a broader analysis of the trajectories major currencies will have. Following the drop in assets at the beginning of the trade issue with the US, Chinese foreign reserves reached a bottom in November. They have since been slowly climbing back.
The expectations are for FX reserves to slip just slightly to $3.095T from the $3.012T held prior. This would be consistent with the view that the PBOC is comfortable with the trajectory of the yuan for now.