China, the biggest holder of US government bonds, is reported to be considering a halt to purchases of US Treasuries and thereby the financing US government expenditure.
China owns around $1.2 trillion in US Treasuries in a government debt market that amounts to $14.5-trillion.
Analysts say the market for US government bonds is becoming less attractive relative to other assets. For China, trade tensions with the US may also provide a reason to slow or stop buying American debt.
Senior government officials in Beijing reviewing the nation’s foreign-exchange holdings have recommended slowing or halting purchases of US Treasuries, reports quoting sources close to the developments said.
The news comes as global debt markets were already selling off amid signs that central banks are starting to step back after years of bond-buying stimulus. Yields on 10-year Treasuries rose for a fifth day, touching the highest since March.
China holds the world’s largest foreign-exchange reserves, at $3.1 trillion, and regularly assesses its strategy for investing them. It isn’t clear whether the officials’ recommendations have been adopted.
Officials have recommended that China closely watch factors such as the outlook for supply of US government debt, along with political developments, including trade disputes, when deciding whether to cut some Treasury holdings, say reports citing sources.
China’s posture that China could retaliate by withdrawing some of its support for the US debt market is also seen as a warning to the Trump administration against taking a hard line on trade.
The move also comes at a particularly delicate time when the Fed is unwinding its balance sheet into an environment of rising supply.
Treasury’s borrowing needs are likely to rise going forward and the GOP tax bill is expected to add at least $1 trillion to the deficit even after accounting for assumed growth offsets.
The Chinese move comes just as the US prepares to boost its supply of debt. The Treasury Department said in its most recent quarterly refunding announcement in November that borrowing needs will increase as the Federal Reserve reduces its balance sheet and as fiscal deficits look set to widen.
In short, private investors were already going to need to soak up more supply going forward as the Fed steps away. If China considers halting their purchases of US government bonds, that would amount to more quantitative tightening.
But China, with its huge pile of US treasuries, is unlikely to take any hasty decision that would destabilise the market as it would amount to commiting hara-kiri.
China’s central bank, the Peoples Bank of China (PBoC) with its $3.1 trillion foreign exchange reserve and manages the yuan rate against a trade-weighted basket, will also factor into the decision about how to go about diversifying their forex reserves.
The dollar moved sharply lower on this morning’s news and the euro jumped as it’s easy to assume that adding EUR debt is likely to be the favored alternative when it comes to shifting the composition of the war chest.