Emerging market central banks sell some U.S. Treasuries

By Lucia Mutikani - Analysis

NEW YORK (Reuters) - Emerging market central banks, concerned about the global credit squeeze of recent weeks, probably sold a portion of their U.S. Treasury holdings to offset capital outflows, but the trend may be short-lived.

The worst global credit and liquidity squeeze in a decade, triggered by losses on U.S. mortgage-related securities, has resulted in some outflows from emerging markets and a reduction in foreign exchange reserves in some developing countries that has caused some official selling of foreign assets.

"If reserves are falling, you are going to sell some of your most liquid assets to finance the reduction in your reserves," said Brad Setser research director at Roubini Economics in New York.

U.S. Treasury debt is widely considered the safest and most liquid asset in the world.

End of week Federal Reserve's custody holdings data shows that foreign central bank holdings of Treasury debt fell by $48 billion over the past five weeks, erasing almost half of the increase so far this year.

U.S. Treasury data through June already showed some countries lightening their U.S. government security holdings, just before the credit market squeeze began.

"A reversal in private capital flows into emerging markets prompted some central banks to unwind some of the positions they built up when foreign investors were sending money into their markets. That meant selling some of the reserve assets they had previous bought," said Roubini Economics' Setser.

The Russian central bank has been cited by analysts as one of the potential sellers of Treasuries. A Russian government source told Reuters last Thursday that net private capital outflows from that country would exceed $10 billion in August, making it the first month of significant outflows this year.

According to the Russian source almost all of the outflows took place between August 10 and August 24. The Russian central bank intervened in the market last month to support the rouble.

Brazil also saw a net dollar outflow of $39 million from financial-related transactions in August, compared with inflows of $6.09 billion in July. The Brazilian central bank, which had been buying dollars in the spot foreign exchange market daily, has not held an auction since August 13.

AGENCIES IN VOGUE

While foreign central banks have been selling U.S. Treasury securities, Federal Reserve data suggests they have been buying other products such as U.S. government sponsored enterprise debt, or "agency" bonds, such as those issued by Fannie Mae (FNM.N) or Freddie Mac (FRE.N), as well as mortgage-backed securities, which are offering higher yields than government bonds.

"Central bank debt trading desks are quite heavy and recognize that yields have gone up significantly recently, creating a trading opportunity to gain a little more yield," said Tony Crescenzi, chief bond market strategist at Miller, Tabak & Co in New York.

Benchmark 10-year agency debt is yielding 56 basis points above 10-year Treasury notes.

According to Federal Reserve data foreign central banks' U.S. "agency" holdings have risen $24 billion since the end of July.