It was an unnerving piece of data for investors last week, buried halfway down an esoteric spreadsheet released by the US government that tracks how many Treasuries foreign investors buy and sell.
China, the largest foreign creditor to the US government with total Treasury holdings in excess of $1.2tn, sold $20bn of securities with a maturity exceeding one year in March, according to US government data. The sales amounted to China’s largest retreat from the market in more than two years.
The move came shortly before tensions over trade between Beijing and Washington heated up again, with the US slapping additional tariffs on the country’s imports and Chinese officials retaliating with measures of their own. What is more, the sales could not be explained away by the typical ebb and flow of China’s Treasury holdings that result from managing its large reserves to keep the currency stable.
The data reignited fears that Beijing may weaponise its holdings as part of the trade war, wreaking havoc with the biggest bond market in the world, pushing interest rates higher and increasing the US government’s cost of borrowing.
“If China starts dumping its Treasuries, it would cause huge financial instability,” said Mark Sobel, a former Treasury department official who spent nearly four decades at the agency, adding that he considered this an unlikely scenario.
China’s holdings of Treasuries are inextricably linked to the country’s trade with the US. China receives dollars in payment for its exports to America, and then needs to invest that money somewhere. The Treasury market has long been China’s destination of choice because the market is not only big enough to host its enormous reserves, but it also offers a better return than other super-safe investments. Moreover, China avoids currency fluctuations that could come from selling those dollars to buy other assets.
As a result, China’s Treasury holdings typically dip if its reserves fall. It has also sold Treasuries over the past year to support its beaten-down currency, as tariff talk has intensified. On this occasion, though, neither of those forces appears to have been a factor. To some analysts, it seems as though China simply decided to sell.
“One should take notice of a month of sales during a period when reserves appear to be stable by most indicators,” said Brad Setser, senior fellow at the Council on Foreign Relations and a former Treasury department official. “It is certainly something that warrants attention.”
While concerns are mounting, investors and analysts are wary of jumping to conclusions. Mr Setser cautioned that the March data are a snapshot and not yet a trend.
Moreover, few see any alternative for China, other than remaining invested in Treasuries. The benchmark 10-year Treasury yield is currently 2.42 per cent, well above the negative yields on equivalent German and Japanese sovereign bonds and still markedly higher than the 1.03 per cent offered on 10-year gilts in the UK.
Other markets are also much smaller than the US Treasury market, meaning they would struggle to digest any inflows from China’s massive holdings.
“Even it this were to be a threat, it’s a very non-credible one,” said Sonal Desai, chief investment officer for fixed income at Franklin Templeton in California. “What else [is China] going to buy?”
Meanwhile, there are few signs that recent bouts of selling by China have pushed US interest rates higher. In the second half of 2011 China ramped up its sales of Treasuries but interest rates dropped too. The 10-year Treasury yield tumbled from a peak of 3.74 per cent earlier in the year to 1.88 per cent by the year-end, amid a general bout of risk aversion caused by Europe’s sovereign debt crisis.
In 2016, China sought to prop up its currency and sold a net $160bn of long-term Treasuries, with its holdings hitting the lowest since 2010 in November that year. Ten-year interest rates did rise in the US — from 2.30 per cent to 2.44 per cent over the course of the year — but that seemed spurred primarily by the election of President Donald Trump, which brought renewed hopes of growth for the economy.
In March this year, during the latest round of selling, the 10-year Treasury yield slipped 30 basis points over the month to 2.41 per cent.
Still, few disagree that if China wanted to cause an upset in US interest rates by heavy selling of Treasuries, it probably could. The catch is that it would lead to a revaluation of the country’s own US bonds as it sold.
“China selling its Treasury holdings is a nuclear option, because it will hurt their own portfolio,” said Shawn Matthews, a former Cantor Fitzgerald trading head who launched his own hedge fund, Hondius Capital Management, last year.
“It depends on what the goal is,” said Torsten Slok, chief economist at Deutsche Bank Securities in New York. “If the goal is to disturb the US Treasury market, then they may not care about inflicting self-harm.”
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