March 14, 2014 4:02 pm

Plunge in Treasury holdings at Fed triggers speculation of Russia switch

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U.S. 100 dollar bank notes are taken in Tokyo in this August 2, 2011 file picture illustration. The U.S. dollar may weaken and Treasury yields rise when Asian markets reopen on Monday August 8, 2011, though any selling in response to ratings agency S&P's downgrade of the United States is likely to be tempered by the escalating crisis in the euro zone. The S&P cut in the U.S. long-term credit rating by a notch to AA-plus is an unprecedented blow and results from concerns about the nation's budget deficits and climbing debt burden. It called the outlook "negative," signalling another downgrade is possible in the next 12 to 18 months. REUTERS/Yuriko Nakao/Files (JAPAN - Tags: BUSINESS POLITICS)©Reuters

A record weekly drop in US Treasury debt held at the US Federal Reserve by foreign institutions has triggered speculation Russia has switched the bulk of its holding to a third-party custodian, in case its assets are frozen as the crisis over Ukraine escalates.

The Fed reported that its weekly custody holdings of Treasuries held by foreign entities plunged a record $105bn for the week ending March 12 to a 15-month low of $2.855tn from $2.960tn. The previous weekly record drop was $32bn in mid-2013. The total Treasury market is nearly $12tn.

The scale of the decline in custody holdings shocked bond traders on Friday, given that Treasury debt has attracted robust demand from buyers over the past week due to fears over slowing growth in China and the tension between Russia and the West over Ukraine.

The benchmark 10-year yield, which moves inversely to price, dropped to 2.61 per cent on Friday, down sharply from last week’s peak of 2.82 per cent in the wake of better than forecast US jobs growth for February.

“This is a transfer of holdings and not a sale,” said Ian Lyngen, strategist at CRT Capital. “A $105bn sale of Treasuries would have shocked the market and pushed 10-year yields higher by at least 30 basis points.”

A US official said: “If this was indeed Russia who moved their holdings, they are clearly feeling the pressure.”

The threat of economic sanctions against Russia or a freeze on its dollar holdings by western governments was seen by traders as being behind the large drop in custody holdings at the Fed. Placing dollar assets outside of the US is seen preventing the freezing of dollar-based assets.

Russia warned on Friday that it was prepared to intervene in eastern Ukraine, as US secretary of state John Kerry and Russian foreign minister Sergei Lavrov began crisis talks in London.

At the end of 2013, Russia held $138bn of Treasuries, according to official data.

“The timing of the drop in custody holdings makes Russia a more likely suspect,” said Marc Chandler, strategist at Brown Brothers Harriman. “The intervention by emerging market central banks, including Russia, seems far too small to account for $100bn-plus move in a week.”

Lou Crandall, economist at Wrightson Icap, said: “If Russia was one of the many foreign nations that left its Treasury securities at the New York Fed, the escalating talk of sanctions over the Ukraine conflict would give it every reason to move those holdings to an offshore custodian.”

A third-party custodian could be either one of the two large US banks, JPMorgan or Bank of New York Mellon, or – more likely – a non-US player such as UBS, said Mr Lyngen.

Mr Chandler said there was a precedent for such a move given how in 1957 after the Soviet Union invaded Hungary, the Russia-based Narodny Bank shifted dollars from the US and deposited them in its branch in London. That led to the birth of the Eurodollar market, or dollars held outside of the US.

“We can only speculate about who might have decided to move their securities out of the Fed and into a third-party custodian, but one obvious candidate is Russia,” said Mr Crandall.

The Fed declined to comment on custody holdings.

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