Developing nations have been forced to sell Treasuries and use the proceeds to arrest domestic currency weakness, driving a drop in their custody holdings at the Federal Reserve, according to Westpac Banking Corp.
Official holdings dropped by $21 billion in the week to Jan. 29, the biggest decline since the period to June 26, Fed data show. A gauge of 20 emerging market currencies weakened 2.8 percent in January as investors were rattled by a withdrawal of Fed stimulus that’s for years helped devalue the U.S. dollar.
Investors are pulling money from some emerging markets after data showed Chinese manufacturing contracted and Argentina’s unexpected devaluation of its peso further dented confidence. The Fed this week said it would trim monthly bond purchases by $10 billion to $65 billion, sticking to its plan for a gradual withdrawal from unprecedented stimulus.
“This is a useful indication of the scale of the acceleration in pressure on emerging market currencies over the week,” Sean Callow, a Sydney-based currency strategist at Westpac wrote in a note to clients today. It’s “forcing a range of central banks to dip into their reserves to defend their currencies.”
The dollar has climbed against 24 major emerging-market currencies this month with the Argentinian peso sliding 19 percent and Russia’s ruble dropping 6.6 percent. JPMorgan Chase & Co.’s Emerging Market Volatility Index rose to 10.5 percent on Jan. 30, the highest level in four months.
Emerging market turbulence as the Fed continues tapering will create “periodic disturbances” in global markets and expose vulnerabilities in some developing markets, Callow wrote. “Whether EM fragility becomes a dominant theme for 2014 however is open to debate.”