China: Officials considering slowing or halting Treasury purchases - Westpac

Chinese officials are reportedly considering slowing or halting Treasury purchases, heightened trade tensions and diminished attractiveness relative to other assets apparently key considerations, according to analysts at Westpac.

Key Quotes

“The impact has been measured and hardly what one would expect from a potentially major strategic shift: USD index -0.5% on the news but trimming losses, US 10yr yields +4bp, risk appetite dented slightly.”

“Reports that China (and others) want to diversify away from Treasuries surface from time to time but little comes of it. For all the noise COFER data show remarkably static global USD reserve holdings, ranging between 61% and 65% over the last decade, the latest data point of 63.5% right on the decade average.”

“Timing may not be coincident – global trade issues seem set to come to the fore with Trump to attend the Davos World Economic Forum and administration officials reportedly close to deciding on whether to impose trade sanctions on China (solar panels, steel and aluminium reportedly the focus) i.e. it may be opportunistic political signaling.”

“Conditions ideal for China to “send a shot across the bow”, CNY depreciation and capital flight pressures have eased, China has allowed CNY to rebound in past month and now stating it is to be more flexible.”

“China’s Treasury holdings were rebuilt in 2017 (+$130bn to $1189bn based on Treasury TIC data) after being rundown in 2016. Further purchases may slow regardless with holdings now back to more or less the average of 2011-2015 (i.e holdings back to a more desirable portfolio target).”

“China can (and will) alter the composition of reserves at the margin but material adjustment will be costly and alternatives are limited – US yields are substantially higher than other core markets (bunds yield 200bp less than treasuries) while comparable yielding markets lack liquidity. Also, China’s exchange rate is much more flexible but US holdings are still to a degree an exogenous outgrowth of the interaction between trends in China’s trade surplus, capital flows, exchange rate management policy and interest rate differentials (all inter-related).”

“US Treasuries were already on the backfoot early in the new year and the USD has been under pressure amid “global reflation”. The news report more than anything exacerbates the bearish short term narrative for Treasuries built around deteriorating supply-demand dynamics thanks to Fed balance sheet unwind and deficit financed tax cuts.”

“Admittedly strong overseas buying has often been cited as a contributing factor behind low US yields via a reduced term premium but there are many other factors at play too, i.e. US/global inflation and inflation expectations remain low, long term growth prospects remain capped by less favourable demographics and still low productivity.”

“Bottom line: news that China might slow or halt treasury purchases could be opportunistic political signaling amid developing trade tensions. The USD and US fixed income have been on the backfoot in the new year already, today’s report plays to the developing trend. China can alter composition of reserve holdings at the margin but wholesale change seems unlikely given opportunity costs of underinvesting in a very liquid high yielding reserve asset. Long term the US$ and yields will be determined by growth and inflation, monetary policy and fiscal/current account trends rather than any particular flow.”