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HSBC Reserve Management Trends: How central bank reserve managers are adapting their strategies amid a rapidly changing environment

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Geopolitical escalation; an evolving economic cycle; the role of the dollar and ongoing market volatility: The key trends and risks driving central bank strategies are shifting – resulting in reserve managers realigning their approach across a number of significant areas.

US-China tensions, the ongoing conflicts in the Middle East and Ukraine, multiple elections around the world with the possibility of unpredictable outcomes and potential political interference in Central Bank independence have all contributed to central bank reserve managers citing geopolitical escalation as the biggest risk they face in 2024.

The finding, revealed in the 20th annual HSBC Reserve Management Trends Report, marks a distinct shift from 12 months ago – when above-target inflation was the most concerning issue for central banks – and is one of a number of moving factors resulting in reserve managers realigning their strategies on a number of fronts.

Reserve managers are also concerned that these geopolitical events could further significantly impact global growth trajectories and supply chains – as well as triggering other risks such as energy shock, inflation and a need for bigger fiscal stimulus.

As a result, reserve managers are increasingly incorporating geopolitical risks into their risk management and asset allocation decision-making. In fact, more than two thirds of reserve managers say these are now incorporated – with the most common strategic change being the location of investments, followed by changes with respect to their counterparties and the currencies invested in.

Concern over bond market volatility

Bond market volatility and dislocation is expected to be another key source of risk for reserve managers in 2024-25.

Of the reserve managers that cited this as a major risk, the most prominent concern was inflation data surprises, followed by US Treasury supply and a financial stability event third.

In terms of which countries’ bond markets will see relative outperformance/underperformance, reserve managers were clear that they think US bond markets will outperform relative to other G7 countries in 2024-25. A majority ranked the US first – and were equally clear about Japan relatively underperforming. Canada and the UK ranked joint second by mode in the category.

Duration lengthening strategies evident in contrast to last year

In a further strategic shift, central bank reserve managers appear to be increasing the duration of their reserve portfolios – in expectation of the end of the monetary policy tightening cycle.

In fact, more than half of the central bank reserve managers surveyed in the HSBC Reserve Management Trends Report have now made this decision – in contrast to last year’s findings, when more than half said they had reduced duration to limit the impact of higher yields in long-term maturities.

The appetite for diversification

An increasing number of reserve managers are saying that, in the current market environment, they expect their peers to accelerate the pace of diversification.

That was the view of more than a third of the reserve managers surveyed – who indicated this is being driven partly by the search for greater performance but also by the need to diversify and protect their portfolios in the current uncertain economic and political climate.

Just over half of reserve managers said they do not anticipate changing the level of diversification of their own portfolios, but more than a third said they will accelerate it.

De-dollarisation continues – but unlikely to accelerate

Of course, another much-debated and closely watched issue that has a strong impact on global markets more broadly is the de-dollarisation of FX reserves.

While a majority of reserve managers agree that de-dollarisation will continue to increase – it is notable that most feel this will only be on a gradual basis, with very few believing the pace of de-dollarisation will accelerate moving forward.

The majority of central bank reserve managers said they expect the renminbi’s share to remain in the current range, below 3% by the end of 2024, and only around 20% expect the renminbi’s share of global reserves to reach at least 10% by 2035. Therefore, the vast majority of reserve managers expect the renminbi’s share of global reserves to remain between 4-12% in 2035 – meaning only a gradual shift over the next decade.

However, the process of de-globalisation is creating political polarisation that could contribute to changes in the global financial system as well – and de-dollarisation has now become part of the policies and strategies of different countries to promote a more democratic international economic order. There have been increasing initiatives in the areas of trade and financing to reduce dependence on the US Dollar.

Regardless, with an overwhelming proportion of respondents to the HSBC Reserve Management Trends Report saying they do not expect to see an acceleration of de-dollarisation, it is clear the USD will remain as the dominant reserve currency in the long as well as the short term.

In the eurozone, higher interest rates have increased the euro’s attractiveness as a reserve currency. This year, more than three fifths of respondents said they think the euro has become more appealing.

AI to the fore

While it is clear reserve managers are adapting their strategies in response to emerging risks and a changing economic climate, another factor influencing their strategies is artificial intelligence (AI) – which they see has having a positive impact on their future activities.

According to the HSBC Reserve Management Trends Report, reserve managers overwhelmingly view the potential of AI positively – with more than 90% believing it will help them optimise their operations.

The hope is that, with the advent of AI, portfolio management can be enhanced with data-driven insights and automation. AI has the potential to identify optimal asset allocation, for example, rebalancing strategies, risk-adjusted returns, and tax efficiency for each portfolio.

AI could also execute trades, monitor portfolios, adjust asset weights, and generate reports automatically and efficiently – as well as helping to reduce portfolio risks by identifying correlations between different assets, sectors or regions, and suggesting optimal diversification strategies accordingly.

As such, the reserve managers surveyed in this year’s report view AI as playing a pivotal role moving forward – with a majority saying it will most prominently be used to support reporting, followed by trading and execution, risk management, and portfolio management.

Adapting for success

It is evident from this year’s HSBC Reserve Management Trends Report that reserve managers are showing considerable adaptability and flexibility – evolving their strategies and focus amid a moving feast of risks and opportunities and a fast-changing political and economic backdrop.

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