Following today’s blockbuster, if still unconfirmed, report from Bloomberg that China is contemplating slowing or halting outright the purchase of US Treasurys in retaliation for an escalating trade confrontation with the US, which in turn led to a modest, if brief, selloff across the curve, some have asked if this is merely posturing or if China is actually ready to pull the plug.
This question breaks down into three distinct parts.
The first is whether China is ready to not only violate global capital markets, in the process certainly hurting itself as the largest offshore holder of US debt, but has the determination to proceed with this plan once it begins, even after the “BTFD” algos emerge. This was at the core of Steven Englander’s argument presented earlier today:
Can [China] afford for asset markets to blow this off completely and yet again ‘buy the dip’? For any threat to be credible, the impact probably has to last more than six hours. If there is a wave of market-close buying of assets, any future retaliation would have to be even stronger, and this would carry risks both to China and other countries.
Then, there is another, even more important question: is China ready to replace the US as the global bogeyman, i.e., the catalyst for what could be a global recession if the Chinese “retaliation” goes too far, to wit:
How will [China] react to the rest of the world saying “Thank you for appreciating my currency, raising my bond yields, and putting downward pressure on equity prices?” China’s move, if pursued or if it unleashes other concerns, could raise questions about the longevity of a bull market that was finally putting to bed the legacy of the GFC, the EZ debt crises and the EM sell-offs of recent years. If their bilateral trade dispute with the US leads to a global asset market sell-off, their case for establishing themselves as an alternative global financial lynchpin weakens. Most likely they take very limited actions, even pull back some of the comments, but imply this is a warning that they can retaliate if the US is too aggressive or irresponsible.
Then there is the most important question of all: is China even capable of hurting Treasury pricing for an extended period of time: as today’s 10Y Treasury sale showed, there was a surge in demand following the selloff in US paper over the past 48 hours, implying that should China be willing to liquidate its $ 1.2 trillion in TSYs, someone may be more than happy to buy these at a same, or better yet, lower price. This is the argument made by Bloomberg’s macro commentator Ye Xie earlier today.
China added $ 131b in Treasury holdings in the first 10 months of last year, or $ 13b a month. How much U.S. government securities traded among primary dealers in every single day last year? More than $ 500b. While China’s actual purchases may be bigger than the official data because it may have covered its trail in accounts in places such as Belgium, the truth remains that the ocean is just too big for one whale to make a splash, even as large as China is.
If anything, one could make an argument that a reduction in China’s holdings could, at times, drive down yields, instead of pushing them up, as shown in this chart. When the PBOC sold Treasuries in its foreign reserves in early 2016 to offset capital outflows, it may have helped spur demand for safe havens from investors who were concerned about a China crash. As China’s economy started to recover in the second half of 2016, it resumed the purchases and the yields went up slightly.
Xie made another point: in light of China’s plunging current account surplus (which according to some calculations has now become a deficit), “the big picture is that the heyday of China’s reserve accumulation — its appetite for Treasuries — is long gone.”
In other words, China may be halting Treasury purchases not because it is making some profound political statement, but simply because it no longer has the need, or purchasing power, to buy them.
Ok fine, but what about the opposite: will China be selling Treasurys?
The answer to that will have to wait as it depends as much on China’s own strategy, complex as it may be, as what Trump may say or tweet at any given moment. Therefore making any predictions on this topic is just as irrational.
What we do know with near certainty, however, is whether China, or other foreign official entities, have been dumping Treasurys in recent months. For that, we go not to the hopelessly inaccurate and delayed Treasury International Capital report, which is far better known for its annual revisions than its accurate “data-keeping”, but to the Fed’s weekly H.4.1 statement, and specifically the line item for “Securities Held in Custody for Foreign Official and International Accounts: Marketable U.S. Treasury Securities.”
As regular readers know, this is the most comprehensive, and most concurrent, data set available demonstrating what, if anything, foreigners are doing with their US Treasurys, the vast bulk of which are kept not offshore, but actually at the NY Fed as “custody” securities.
What this data shows is that after hitting an all time high of just over $ 3.05 trillion in the second week of December, foreign-held Treasurys are virtually unchanged, or just a modest $ 30 billion lower in the last two weeks, to $ 3.02 trillion. Compare this number to the sub $ 2.8 trillion hit in late 2016 when the combined selling by China and “Belgium” took US Treasury holdings in custody to the lowest level since mid-2012.
In other words, when the Chinese Treasury selloff begins, we will know. For now – and contrary to what Bill Gross said earlier – it certainly has not.