Are global reserves moving away from the dollar?

The share of dollars has been declining, but not consistently across countries. Some have increased their dollar share while others have reduced their dollar exposure. In a NY Fed blog posting, “Are Central Banks Moving Out of Dollar Assets?” the authors try to disentangle the problem through two channels. One is the preference channel, which represents a change in the desire to hold a specific currency. For example, it can be a desire to hold fewer dollars. The second channel is the reserve change channel, which represents a change in the overall amount of reserves held. If a central bank has less dollar exposure but increases its overall reserves, overall dollars held will decline when central bank data is aggregated. 

What is clear is that the change in preferences has centered on a limited number of large central banks and does not represent a shift in behavior across all reserve holders. Second, some of the decline in the dollar share of foreign reserves is caused by large reserve holders that have had a lower allocation of dollars but have seen an increase in overall reserves. 

In conclusion, dollars as a percent of all reserves have declined over the recent reporting period, but the reasons for the decline suggest it is not a wholesale rebalancing of dollar exposure.  

 

Bond markets - is this just a return to normal

 

There is consternation in the bond markets that may be unwarranted. Rates are higher, and the sell-off has been strong, but we are returning to the normality seen before the GFC. Was the post-GFC period normal, or is the current environment, with a positive real rate, an inflation premium, and a term premium, the norm? 

I would argue that the current environment is a return to normality, and the low interest rates during the QE period were abnormal. The Fed and the Us Treasury cannot be in a continual mode of amping up the economy. There has to be a focus on inflation and controlling credit excesses. Of course, there is a threat of recession, and people will be in need, but the labor market is close to full employment, and inflation is well above target. 

Should we expect lower bond yields, or is the market just reflecting reality? 

Exchanges mergers and EU Capital Market Union (CMU)

An important news article states that Euronext is open to a merger with Deutsche Börse, which would be an important step in the one-European-exchange move to unify rules and regulations for stock trading; that is the hope. One of the most urgent and important discussions about competition in EU integration is reducing bottlenecks in capital markets. The EU has been a laggard in venture capital and private equity funding. New companies look to the US for capital. The disperse set f stock marklets redcues liqudity and makes any listing more expesneive in Europe. A consolidated exchange environment should allow for better listings, more liquidity, and lower operating costs across European markets. 

It is early to say whether there will be any merger announcement, yet a discussion is a good first step. 

Inflation expectations are still high

 

Inflation won't be tamed in the near term. First, CPI is staying above 3%, not 2%. Second, PPI isn't supporting lower inflation. The PPI is usually volatile, but commodity prices are rising with greater volatility.

While longer-term inflation expectations suggest inflation could get closer to the 2% target, one-year expectations aren't falling toward 2% and are centering around current levels above 3%.