While the market's attention has recently focused on what is taking place in the world of unsecured funding, where Libor has been blowing out to 6 year highs, pushing the benchmark to the highest level in 6 years...
... and where the the 3 month/ 6 month and 1 month/3 month Libor bases have soared to the widest since the financial crisis, due to a funding pull back for issuers in commercial paper ahead of money market reform (something which sadly means the Ted-spread is no longer a relevant metric of funding stress as explained before)...
... another curious thing is taking place in the plain-vanilla bond market, where according to the latest Fed Reserve balance statement, Treasury holdings in custody at the Fed - which peaked at $3.03 trillion in July 2015, tumbled by over $17 billion to $2.871 trillion as of the week ended August 10. This has brought the total Tsy custody holdings to the lowest since 2012 (apart from a sudden decline in March 2014 that was reversed over 2 subsequent weeks linked at the time to the sudden military escalation between Russia and Ukraine).
While TIC data released this Monday will give us some much needed, if substantially delayed, data on reserve manager activity as of June, the hypothesis is that OPEC countries such as Saudi Arabia are once again quietly selling Treasuries to raise cash in an environment of low oil prices and the consequent budgetary tightness, according to Citi's Jabaz Mathai.
Additionally, Bloomberg cites strategists, who say that the drop "reflects FX operations by some of the smaller central banks." The drop probably has been driven “by the smaller central banks being forced to sell to raise dollars to defend their currencies,” or simply to fund “general fiscal stimulus in struggling global economies,” according to Ian Lyngen.
In other words, while the world is blissfully content to ignore the currency wars taking place behind the scenes, various central banks are scrambling to defend their currencies by selling USD assets.
While other suggestions have been proposed, including the use of the Fed’s reverse repo facility at unpublished overnight rates that may exceed yields on bills, according to BMO strategist Aaron Kohli, the most likely explanation is one of ongoing stealthy FX warfare and a "refill" of FX funding needs.
This confirms what we wrote a week ago in "Why Oil Under $40 Will Bring It All Down Again: That's Where SWFs Resume Liquidating." So far, judging by the market's relentless grind higher, few equities have been sold, however the US Treasury market appears no longer immune to the recent drop in crude oil, and this is being reflected in Treasuries parked in custody at the Fed.
The corollary of this is the increase in dealer inventory of Treasuries, and the cheapening of Treasuries to OIS, which is highlighted in the swaps section.
The good news is that while oil exporters and EMs may be selling TSYs, there is a persistent bid coming from countries such as Japan. Indeed, when looking beyond Treasury transactions by reserve managers, the most recent data on Japanese investors shows continued purchases of long term US debt securities, about 20bn USD in June which also includes mortgages and other fixed income securities.
So while the bulk of traders take off the next 1-2 weeks for vacation, keep a close eye on this balance of FX-war waging EM sellers vs yield-chasing DM buyers to see who ends up winning, at least in the short term. Also of note, if the recent squeeze in oil fails to push the price of crude higher and, worse, if oil again retests $40 or lower, the next question is when will reserve managers shift away from selling just bonds and resume liquidating stocks, as they did in late 2015 and early 2016, something we cautioned about one week ago.