Global Macro Strategy
November 24, 2015
Peter Donisanu, Global Research Analyst
Analysis and outlook for the global economy
- On November 30, key leaders at the International Monetary Fund (IMF) will meet to determine whether the Chinese yuan will be added to the IMF’s list of reserve currencies.
- It has become increasing likely that the IMF will add the yuan to its special drawing rights (SDR) currency reserve basket.
What it may mean for investors
- We believe that U.S. dollar dominance will be around for a while longer, even with the potential adoption of the yuan by the IMF.
- Nevertheless, a positive outcome for the yuan could remove a brick in the wall of worry surrounding global economic growth and provide a boost to financial-market sentiment toward risk assets, particularly global stocks.
The Chinese Yuan: Is U.S. Dollar Dominance Over?
On November 30, the IMF’s Executive Board will meet to decide on whether the Chinese yuan (RMB) should be included in the Fund’s special drawing rights (SDR) currency basket. Earlier this month, an IMF staff report indicated that policymakers in China have implemented the market-based reforms necessary for inclusion as a reserve currency with the IMF. Christine Lagarde, Managing Director of the IMF, also expressed her support for the yuan’s inclusion in the currency basket. Ultimately, it will be up to Executive Directors of the IMF to vote on the currency’s inclusion as a reserve currency.
It has become increasingly likely that there is enough political backing, including from the U.S., to support adoption of the yuan by the IMF. Given China’s completion of technical hurdles for inclusion, and likely political support, we expect a favorable outcome for the yuan following the November 30 meeting. The announcement could again prompt questions as to how quickly the yuan could overtake the U.S. dollar as a preeminent global reserve currency. While a favorable outcome for the yuan may increase the currency’s standing as a global currency, a key distinction should be made between the IMF’s use of the yuan as a reserve currency and global adoption of the currency as a dominant store of value.
We believe that what makes a reserve currency a dominant store of value, like the U.S. dollar, is its usage—along with the institutions that support its use. In other words, a global reserve currency is not necessarily set by vote, but by how often a currency is used in transactions for trade, savings and payments. To this point, the yuan has some work to do to catch up to the U.S. dollar:
Trade: Last year, RMB-denominated transactions accounted for 3.9 percent of world trade. This is compared to euro-denominated transactions at 7.2 percent and U.S.-dollar-denominated trade at 85.6 percent total trade volume.
Savings: In 2014, global debt market transactions were dominated in the U.S. dollar (42.1 percent), euro (37.1 percent), and British pound (11.6 percent) whereas RMB-based utilization lagged behind (1.4 percent).
Payments: For business-to-customer international transactions, U.S. dollar (41.6 percent), euro (36.6 percent) and British pound (4.3 percent) remain dominant currencies.
From an institutional-support perspective, use of the yuan as a reserve currency by central banks remains low. At the end of 2014, RMB utilization as a store of value on global central bank balance sheets accounted for just 1.1 percent of total central bank assets. This is compared to central banks holding U.S.-dollar-denominated assets at a rate of 63.7 percent of total assets and euro-denominated assets at 21 percent. Given the yuan’s still low utilization as a trade, savings and payments currency—and its limited institutional adoption—we expect its role as a global store of value to be modest in the near term, especially when compared to the usage of the euro and British pound.
The developments in China over the past month have been positive and continue to point toward economic stabilization rather than outright contraction. More broadly, we continue to expect slower, but still positive, global economic growth. Nonetheless, we believe that as economic releases point to stabilization, positive data, supported by easy global monetary conditions, should boost financial-market risk appetite. This, in turn, supports our bias toward stocks over bonds and favoring risk assets where economic momentum is strongest.
We continue to expect momentum to be strongest in the U.S. and Europe and suggest that investors consider overweighting developed-market equities broadly and U.S. and European equities in particular. An uneven economic growth outlook in emerging markets—coupled with market uncertainties—has us underweighting emerging-market stocks relative to their strategic allocations. For international bonds, we expect the U.S. dollar to remain strong as the Federal Reserve moves toward its first rate hike—potentially putting downward pressure on international developed-market currencies, particularly the euro and yen, and detracting from repatriated returns.
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Stocks offer long-term growth potential, but may fluctuate more and provide less current income than other investments.
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