Despite gloomy predictions and concerns over spiking bond yields, analysts have struck a fairly sanguine tone over China’s acceleration in the selling of its dollar-denominated debt reserves.
China is the world’s largest holder of U.S. debt, but Societe Generale analysts estimate that the People’s Bank of China (PBoC) has sold at least $106 billion of reserve assets since its currency devaluation this month. A Bloomberg report on Thursday, citing people familiar with the matter, confirmed that China had cut its holdings of Treasurys to raise the U.S. dollars needed to support the yuan.
Logically, this would be seen as bearish for U.S. bond prices – which have an inverse relationship with yields – but the rates strategy team at Rabobank believe the impact is less than clear cut.
“The obvious conclusion here is that PBoC (People’s Bank of China) selling is bearish. However, this could be wrong in precisely the same way investors tend to mistakenly believe QE (quantitative easing)purchases are bullish,” the bank said in a note on Friday morning.
China is the biggest holder of reserve assets in the world, holding a combination of bonds, currencies and commodities like gold. It held $1,271 billion in U.S. Treasurys at the end of June, according to data from the Treasury Department.
Chinese officials have been busy trying to manage the downward pressure on the yuan since Beijing announced a currency devaluation on August 11. The typical method to do so would be to sell foreign exchange reserves in order to depress their price, thus pushing up the price of its own currency.
Selling Treasurys would be one way of raising enough dollars to then sell and try to balance the currency.
Rabobank argued that Beijing’s selling of Treasurys probably reflected capital flight out of China, which would push the yuan down. This in turn would reflect concern over the Chinese economy which would “very probably result in falling inflation expectations globally.”
What would falling inflation expectations do? It would probably underpin demand for U.S. Treasurys, with fixed income traditionally performing well in an environment of low inflation.
Neil Mellor, senior currency strategist at BNY Mellon, added that there was a distinction to be made between China “dumping” U.S. Treasurys as some sort of economic war tactic and simply adjusting its reserve management.
“Though feared by policy hawks in the U.S., the former scenario has long been held as an unlikely (at least in any meaningful way) given that it would be self-harming,” Mellor told CNBC via email.
Selling U.S. debt at a rapid pace would devalue the rest of the dollar-denominated assets that China currently holds, he argued.
U.S. bond yields have held relatively steady during the stock and commodity market turmoil this week, so it fears of economic combat between the U.S and China appear overblown.
The yield on the benchmark 10-year U.S. Treasury note was at around 2.141 percent at the time of China’s devaluation. At the start of this week, it dropped below 2 percent, but was back trading at around 2.151 percent on Friday morning.
So what can be concluded? It seems that fears of an interest rate hike by the U.S. Federal Reserve and China’s hefty selling have not caused investors to shun the asset class.
Nonetheless, Rabobank added that if China continued to push its currency lower, than other countries, most especially in Asia, would move to depreciate their own currencies. This could mean aggressive buying of dollar-denominated assets as their central banks try to push the dollar higher against the domestic currency—although this would be the reverse of China’s current strategy.