Fedreal Resereve Custody Holdings

The Federal Reserve has long competed with the private sector in offering custodial services to foreign central banks. The Federal Reserve reports is custodial holdings every week. In the most recent week, through Wednesday, custody holdings of Agencies and Treasuries actually fell by about $250 mln.

This is a bit a quirk and is the exception to the general trend which sees foreign central banks as regular buyers of Treasuries (and often Agency paper).

Since the end of last year, foreign central banks have increased their holdings at the Federal Reserve by $57 bln. This is actually the weakest quarterly gain (in percentage terms) since Q4 07.

There are likely a number of contributing factors. First, the rise in custody holdings in H2 10 were outsized at more than $250 bln. The slower pace may reflect a "normal" rebalancing process. Second, hot money inflows into a number of emerging markets, especially in intervention prone East Asia, ceased in through much of Q1 and therefore there was less need to neutralize those flows through intervention. Indeed, in the first two months of the year, many of the likely suspects like Korea and Taiwan (but also Thailand, India, and Hong Kong) saw their currencies decline against the dollar. Of the much followed emerging Asian countries, only Indonesia saw more than a 1% currency appreciation.

In addition, there has been some thought that a number of emerging market countries, experiencing higher inflation as a result of the increase in commodity prices and/or closed output gaps and local bottlenecks, suggest some countries may be more willing to allow currency appreciation.

Nevertheless, it is not an all or nothing proposition. A number of central banks in Asia, including the Philippines, Malaysia, Korea, Indonesia, Thailand, India and Taiwan are all rumored to have intervened earlier today and bought dollars. Market talk suggest the cumulative intervention today could be as much as $5-$8 bln. Companies that track money going into funds are reporting a resumption of inflows into emerging market equity funds.

It should not be surprising if custody holdings at the Federal Reserve resume their rise in the coming weeks.