Dollar Dives After Chinese Threaten Halt to Treasury Buying

Market Drivers January 10, 2018
Buck buckles after PBOC says may slow UST buying
Global yields rise
Nikkei -0.26% Dax -0.84%
Oil $63/bbl
Gold $1324/oz.
Bitcoin $1400

Europe and Asia:
GBP UK Trade -12B vs. -11B
GBP UK MP 0.4% vs. 0.3%

North America:
No data

The dollar tumbled in morning London trade today after China announced that it may purchase fewer US Treasuries in the upcoming year.

In a statement, Chinese authorities noted, "Investment strategies don't concern daily purchases or sales. They closely watch factors such as the outlook for supply of US government debt, along with political developments including trade disputes between the world's two biggest economies, when deciding to cut some Treasury holdings."

The move was seen as a thinly veiled attempt by the Chinese government to force the Trump reconsideration to reconsider any trade sanctions against the world's second-biggest economy by GDP. So far there have been no tweets from POTUS in response, but the move injected a clear note of danger for global capital markets and could send risk appetite scurrying on fears of a new trade war between China and US.

The Chinese are applying pressure to the Treasury market just as the Fed is about to step away from being the buyer of last resort. Over the past few years, concerns about Chinese holdings of US Treasuries evaporated as the Fed became as much as 40% of the market. This year, however, Fed will begin to wind down and even shrink its balance sheet, stepping away from the US Treasury market just as Chinese are threatening to throttle demand. The move also comes at a time when US passed a massive tax cut that is expected to expand the deficit by 1 Trillion dollars this year.

This combination of stress factors could combine to wreak havoc in the capital markets. The dollar was already notably weak ahead of today, despite the fact that US data remained strong and yields continued to rise. This change of dynamic suggests we may be in the midst of a regime change in the market where the dollar actually falls as US yields rise on fears of deficit expansion and debasement of the currency.

For now the move has been relatively contained, with EURUSD popping back above 1.2000 and USDJPY dropping towards 111.00, but if both pairs break their multi-month highs and lows, that would suggest that this turn of events is much more serious than it seems and the dollar could see a sustained selloff over the medium term horizon.