Fears China could halt or slow its purchases of Treasurys helped accelerate a selloff in the Treasury market Wednesday, but analysts and economists question whether Beijing poses a significant threat.
Bloomberg, citing unidentified people familiar with the matter, reported that senior Chinese government officials have recommended slowing or halting purchases of U.S. Treasurys, noting that it was unclear if the recommendations had been adopted. Bloomberg said the recommendations reflected ideas U.S. government debt is becoming less attractive relative to other assets, as well as trade tensions between Beijing and Washington.
Uncertainty over the plans of the largest foreign holder of U.S. Treasurys contributed to another leg higher for U.S. yields, with the 10-year Treasury yield
climbing close to 2.60%, trading at its highest since March. Prices for U.S. government paper fall when yields rise.
Stocks took a breather from their record run Wednesday, pulling back modestly as yields continued their rise. The S&P 500
which began the year with a streak of six consecutive record finishes, was off 0.2%.
“China’s holdings are less concentrated in U.S. fixed income than any time in the last decade. Yet, they are still large enough to command this type of instant reaction,” said Jim Vogel, an interest-rate strategist for FTN Financial, in a note.
As one of the largest holders of Treasurys, China has had an outsize impact on the U.S. bond market, its presence perhaps only second to the Federal Reserve. Analysts have tied depressed long-term yields in part on China and other large central banks in emerging markets that have accumulated foreign-exchange reserves, usually Treasurys, to support their currencies.
China had $1.19 trillion worth of U.S. government paper on its books as of October, according to Treasury Department data. Investors say the actual figure could be much higher as the country is suspected of parking some of its holdings in custodial accounts in other countries, including Belgium.
A diminishing factor?
But does China really pose a threat? Analysts are quick to point out that China has become less active in the market and has overseen a gradual decline in its total stock of Treasurys, yet yields have remained historically low.
“It’s already been happening. China has been drawing down its reserves and its holdings for a couple of years. During that period, U.S. Treasury yields fell to their lowest point in their history,” said Patrick Chovanec, chief strategist for Silvercrest Asset Management, in an interview with Bloomberg TV.
China shed $188 billion of Treasurys in 2016, bringing its overall holdings to $1.05 trillion at the end of that year. The yuan’s weakness forced the central bank to drain its foreign exchange reserves to buttress the currency. (see chart below).
But China’s actions didn’t spark a yield-boosting selloff in Treasurys. In fact, the 10-year Treasury yield fell to 1.32% in July 2016, an all-time low.
China’s purchases picked back up in 2017, reflecting purchases of $21.1 billion in June and $24.6 billion in August, while activity in other months was relatively muted, noted analysts at Jefferies.
As China unloaded Treasurys, a wellspring of other buyers stepped in. Money-market funds dealing with fresh regulations, banks responding to revamped capital requirement rules and private investors managed to take up the slack from China and other emerging market central banks, wrote Guillermo Tolosa, economic adviser for Oxford Economics, in a September note.
Moreover, analysts say larger economic forces dictate the central bank’s decisions and that the PBOC had much less discretion over how it manages its foreign-exchange reserves than assumed. China’s burgeoning trade surplus and the need to steady the currency have controlled the amount of Treasurys it carries.
“If the People’s Bank wants to keep the renminbi broadly stable, it can’t choose how much foreign exchange it buys or sells,” said Mark Williams, chief Asia economist for Capital Economics. “The upshot is that for most of the last few years, the People’s Bank has been selling rather than buying foreign assets because that is what China’s currency policy has required it to do.”
Market participants said the focus on China’s moves simply reflect recent market jitters. The Treasury selloff rattled nervous investors sensitive to fresh catalysts for rising yields, giving heightened attention to the speculation over the nation’s central bank decision-making but obscuring the fundamental drivers of the selling in the bond market.
Rising Treasury yields “don’t have that much to do with China. It really has to do with the fact that you’re right now seeing a big fiscal stimulus pour into a big economy that people increasingly feel is at or near full employment,” Chovanec said, referring to the U.S. tax cuts signed into law last month. “It’s taking place in the context of rising rates.”
Fears that global central banks will pull back from their asset purchases and that the Republican tax bill along with tight labor markets will spur inflation have dulled the attraction of long-dated Treasurys.