Foreign Central Banks Cut Treasury Holdings by Record

Holdings of U.S. Treasurys by foreign central banks has fallen by a record amount over the past four weeks according to the latest Federal Reserve data.

The Federal Reserve headquarters in Washington, DC.
The Federal Reserve headquarters in Washington, DC.

The net $69 billion drop in Treasury holdings registered at the Fed by foreign official institutions comes as benchmark yields ended 2011 near record low levels and when the U.S. central bank is conducting Operation Twist, its $400 billion program to sell shorter-lived Treasury bonds and buy those with longer maturities.

The decline in foreign holdings of Treasurys in recent weeks has not resulted in higher yields and lower prices because other investors have sought the safety of US debt.

“Given where the 10-year Treasury is ending the year, it’s difficult to say the flows are a bearish move,” said Ian Lyngen, strategist at CRT Capital.

The yield on 10-year notes was set to end 2011 below 1.90 percent on Friday and the Barclays Capital index of long-dated Treasurys has rallied nearly 30 percent this year, its best annual performance since 1995.

“While other buyers have willingly taken up the torch up to this point, it seems clear that this [foreign official flows] source of demand has waned since Operation Twist took yields to these levels and this investor base has little interest in sub-2 percent 10-year yields,” said John Briggs, strategist at RBS Securities.

The drop in foreign holdings would be far more pronounced had Japan not intervened to buy dollars and sell yen during August and October. The proceeds of dollar purchases, seen in the vicinity of $100 billion in October, went mainly into the Treasury market.

“If not for the bulge of purchases at the end of October due to Japanese intervention it’s fair to say we would have seen consistent falls in holdings of Treasurys for most if not all of the second half of the year,” said Mr. Briggs.

The previous record four week drop for custody holdings at the Fed was a $56 billion decline in September, when the 10-year yield dropped to 1.67 percent, its lowest level since 1945.

With September and December marking the final months of the third and fourth quarters respectively, the sales by foreign central banks may be nascent evidence of a new trend.

“Once upon a time, foreign official institutions were more likely to boost the amount of Treasury debt held at the Fed on the eve of major reporting dates,” said Lou Crandall, economist at Wrightson Icap. “Whether due to underlying investment patterns or to changes in custodial arrangements, foreign holdings of Treasurys at the Fed are now more likely to shrink than expand at the end of the quarter.”

Late on Friday the New York Fed announced that the central bank plans to purchase approximately $45 billion and sell approximately $44 billion in Treasury securities under Operation Twist over the month of January.