Wednesday, July 9, 2008

Foreign central bank holdings of government debt still increasing

Brad Setser points to an interesting fact that foreign central banks keep buying US treasury and agency debt in record amounts. In the first half of 2008 central bank's holdings of Treasuries and Agencies have increased by a staggering $283.5 billion. This is even more surprising since the US dollar has depreciated significantly during this time period and before. Many have argued in the past and continue to do so that a depreciating dollar could lead to a shift away from the greenback and US government debt, but at least for now Federal Reserve Balances data clearly discount that possibility. Brad Setser in his blog concludes that this may not continue and high inflation in a host of countries compounded with unwanted capital inflows in the case of China may strain the system. The interesting question then will be what happens to interest rates (how high will they go?) and to the global balance of payment impairments that supported supply side economies for the last two decades? The good thing is that we don't have to worry about it just yet.

from Setser's blog:

Between June 4 and July 2, central banks added $45.2b to the custodial accounts at the New York Fed; between May 28 and July 2 (a five week period) central banks added $54.6b to their accounts. That wasn’t as much as April — but it was a lot more than May. It brought the total for Q2 up to $132.7 billion (nearly equally split between Treasuries and Agencies) — only a bit below the $150.8b increase in q1.

Not all central banks make use of the New York Fed, though someone big clearly is. The growth in the the Fed’s custodial holdings consequently is a minimum, not a maximum. Total official purchases of US debt are far higher than the increase in the custodial accounts at the Fed. Nonetheless, it is worth noting that the increase in the Fed’s custodial accounts so far this year, annualized, is well in excess of total recorded official purchases in 2007.

I have continually been surprised by the willingness of the world’s central banks to buy dollars, or perhaps by the reluctance of the leadership of many key countries to shift away from managing their currencies against the dollar. But the strains on the current system — high inflation in a host of countries adding to their reserves rapidly, and unwanted capital inflows into China — have become rather visible.

click to enlarge

update: Wed. July 9th, 4:40 p.m.
Bloomberg reports today that The GSE's Fannie Mae and Freddie Mac have their top credit rating downgraded by credit derivative traders from Aaa (Moody's) to A2.
from Bloomberg:
Fannie Mae and Freddie Mac, ranked Aaa by the world's largest credit-rating companies, are being treated by derivatives traders as if they are rated five levels lower. Credit-default swaps tied to $1.45 trillion of debt sold by the two biggest U.S. mortgage finance companies are trading at levels that imply the bonds should be rated A2 by Moody's Investors Service....The price of contracts used to speculate on the creditworthiness of Fannie Mae and Freddie Mac and to protect against a default doubled in the past two months.

source: The quiet bailout continues …

Brad Setser's Blog: Follow the Money

Fannie, Freddie Downgraded by Derivatives Traders

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