Great Graphic: Fed's Custody Holdings Jump

The Federal Reserve offers custodial services to foreign central banks for Treasury and Agency holdings.  The custodial holdings of Treasuries trended lower from late last September to late March.  Over that six month period, the Fed's custody holdings of Treasuries fell by $138 bln. 

As this Great Graphic, created on Bloomberg, shows the divestment  coincided with a decline in US 10-year yields (yellow line) through the end of January.  However, the Fed's custodial holdings of Treasuries (white line) continued to fall until three weeks ago.  In past three weeks,  the Treasury holdings have risen by $66 bln, recouping nearly half of the six month draw down.  

The recent IMF COFER data showed that the dollars in reserves by central banks that report their allocation actually fell by $31 bln in Q4 14 (though the media focused on the small increase in the percentage of dollars, which is fully accounted for the depreciation of foreign currencies against the dollar).    The Fed's custody holdings of Treasuries fell by about $15 bln in the same period.  

In order to make sense of these fact, we probably need to include another variable:  the dollar.  The US dollar trended higher in Q4 14 and most of Q1 15.  Contrary to the currency war meme, many central banks from developing countries appeared to have intervened to slow their currencies descent.  Despite the talk of a move to a multi-currency regime, the fact of the matter is that most countries continue to measure their currency against the dollar and intervene through the dollar exchange rate.  

As the dollar  stabilized since the March 18 FOMC meeting, from which the market concluded that the Fed will be patient for longer, despite dropping that particular expression, emerging markets were the beneficiary of new capital inflows.  This has been documented by companies that track flows into mutual funds and ETFs.  

Since the middle of March, the MSCI Emerging Market equity index has rallied 11.5% to return to levels seen last September.    Through today, it has advanced for ten consecutive sessions.  On the fixed income side, the JP Morgan Emerging Market Bond Index (EMBI) premium over US Treasuries fell by about 60 bp to and is now at its lowest level since early December 2014.  

As the US dollar stabilized and an early (June) rate hike by the Federal Reserve seems somewhat less likely, some developing countries appear to have moved to rebuild their dollar reserves that had been run-down.    Despite the poor US national employment figures last week, the US dollar has advanced sharply this week.  The euro is off 3.5%, and although sterling is off a more mild 2%, it is at new five year lows.  Most emerging market currencies are lower.  The main exception is the Russian ruble which is up 9.7% on the week and nearly 30% since the start of February.  However, while the central banks that use the Fed's custody services are confidential, Russia is not a likely candidate. Still, if the dollar's uptrend is resuming, then central bank intervention may not be far behind.