China, Japan and other overseas central banks are leaving more of their dollars with the U.S. Federal Reserve as they have liquidated their U.S. Treasuries holdings to raise cash in an effort to stabilize their currencies, government data show.
Foreign central banks' reduced ownership of U.S. government debt, especially older issues, has bloated the bond inventories of U.S. primary dealers and kept U.S. money market rates elevated in recent months, analysts said.
Primary dealers, or the top 22 Wall Street firms that do business directly with the Fed, held $113.5 billion worth of Treasuries in the week ended Feb. 10, the most since October 2013.
As Wall Street holds more Treasuries, foreign central banks have piled more money into the Fed's reverse purchase program where they earn interest income.
“They have been selling their Treasuries holdings and using more the Fed’s reverse repo program,” Alex Roever, head of U.S. interest rate strategy at J.P. Morgan Securities in New York, said on Monday.
On Monday, the New York Federal Reserve's executive vice president Simon Potter said the Fed's repo program for foreign central banks has increased because "the constraints imposed on customers’ ability to vary the size of their investments have been removed, the supply of balance sheet offered by the private sector to foreign central banks appears to have declined, and some central banks desire to maintain robust dollar liquidity buffers."
On Feb. 17, overseas central banks held $246.65 billion in reverse repos, up from $129.78 billion a year earlier, Fed data released last week showed.
Foreign official institutions including central banks sold a net $48.1 billion in long-dated U.S. Treasuries in December, which was a record in monthly sales, according to the Wells Fargo Securities economists.
Overseas government sales of Treasuries came as China and other export-driven economies have dug into their currency reserves to stem capital flights as oil and commodity prices have plummeted. They could reinvest back into U.S. securities whenever jitters about the global markets fade and oil prices find footing after hitting a 12-year low earlier this month, analysts said.
“It’s a place where they could park their cash for a period of time until they decide what they want to do with it, but I don’t think it’s a permanent destination,” J.P. Morgan's Roever said.
Meanwhile, dealers who have been stuck with Treasuries have sought financing in the $5 trillion repurchase agreement. The repo market is not the same as the Fed's repo program.
Dealers pay interest to money market funds and other investors to borrow overnight cash and pledge Treasuries as collateral.
On Monday, the overnight repo rate was last quoted at 0.33-0.41% vs. 0.44% on Friday, according to ICAP. It was as high as 0.57% a month earlier, which was above the Fed's 0.25-0.50% range on policy rates.