By Richard Leong
NEW YORK, Sept 1 (Reuters) - Foreign central banks are cutting back their holdings of U.S. agency and mortgage-backed securities as well as Treasuries in the wake of global market turbulence, Federal Reserve data showed.
If the trend persists and broadens, borrowing costs may rise for potential homebuyers and homeowners who want to refinance.
It is unclear whether the recent sales of debt mainly issued or guaranteed by the three federal mortgage agencies, namely Fannie Mae, Freddie Mac and Federal Home Loan Bank System, is simply a response to the volatility sparked by the slowing Chinese economy and worries about a U.S. interest rate hike by year-end.
Traders are speculating that China and other emerging economies have been shedding Treasuries in recent weeks to defend their currencies in anticipation of private capital outflows due to fears of a weakening global economy. Large declines in the countries' currencies would make it costlier to import oil, food and other critical goods and services.
"You have some of these bonds maturing and they might simply not be reinvesting into them," said Sharon Stark, chief fixed income strategist at D.A. Davidson & Co in St. Petersburg, Florida.
Last week's weak two-year and five-year Treasuries auctions raised concerns about foreign official demand for low-risk government debt.
As of last week, foreign central banks had reduced their holdings of agency debt and mortgage-backed securities at the U.S. central bank for six straight weeks to $285.21 billion, the lowest level since early May, according to the Fed data released last week.
Last week's decline was $10 billion, the steepest drop since June 2012.
Some traders said foreign central banks tend to reduce their mortgage-related debt holdings as the market turns volatile. Downplaying the move as a currency play, they noted even steeper cuts in agency and MBS holdings during the initial episode of the European debt crisis more than three years ago.
"It's primarily on the back of the recent volatility," said Larry Milstein, head of U.S. government and agency trading at R.W. Pressprich & Co in New York.
So far the decline in agency and mortgage-backed securities holdings with the Fed has not caused any significant deterioration in agency and MBS prices, analysts said.
The average interest rate on U.S. 30-year fixed-rate mortgages has fallen to 4.08 percent, the lowest since late May, according to the Mortgage Bankers Association.
Foreign central banks' ownership of agency and MBS at the Fed is comparatively small versus the amount of Treasuries they hold. As of Aug. 26, they had $3.018 trillion of Treasuries, up $5.6 billion from the week before, reversing some of the $15.6 billion drop two weeks earlier.
(Reporting by Richard Leong)