Bond markets took a hit following a report that China could trim its U.S. Treasury holdings.
U.S. bonds sold off on Wednesday — and that may have been the point Markets took a hit following a Bloomberg News report that cited unnamed Beijing officials as saying that China, the largest holder of U.S. Treasury bonds, could slow or even halt its purchases of that debt.
From the Bloomberg News article:
“Senior government officials in Beijing reviewing the nation’s foreign-exchange holdings have recommended slowing or halting purchases of U.S. Treasuries, according to people familiar with the matter.”
Political message? The U.S. government uses Treasury bonds to help finance its debt and deficits.
China holds $1.2 trillion of U.S. debt — more than any country. When it buys U.S. bonds, it is effectively lending money to the United States. Washington uses bond sales to China and others to help finance government operations.
China’s foreign exchange regulator publicly refuted the Bloomberg report on Thursday, saying it cited “false information.” However, the jolt to markets may have been designed as a warning to Washington DC. Possibly in response to recent U.S. clashes with China over trade and other issues.
This recent wrench thrown into markets comes as President Trump appears poised to counter China on its huge trade surplus with the United States, and as Washington loses patience with Beijing over its handling of the North Korea nuclear crisis.
In a note Wednesday, brokerage firm Jefferies said that “If China stops buying Treasuries, the market could suffer.”
China delivered a statement soothing those worries on Thursday.
On Thursday, the Chinese regulator soothed market worries when it said it was already diversifying its foreign exchange reserves, and its Treasury holdings are “market driven.”
Beijing’s indication that it’s not “tied to U.S. bond-buying” indicates more “hardball‘ between the world’s two biggest economies, said Vishnu Varathan, Mizuho Bank economist.
But China is sending another message as well, Rajeev de Mello, head of Asian fixed income at Schroders Investment Management, told CNBC on Thursday.
China “will not just lay passive if the U.S. administration imposes tariffs,” he said. “I think that’s the position they want to be in, that they are a major player and not a small country on the receiving end of the U.S. big stick.”
“It has to be seen as a prelude to possible trade tension, without being a very explicit threat,” added Jens Nordvig of Exante Data.
This is not the first time China has threatened to back away from Treasury bonds.
In 2009, amid the Global Financial Crisis and early in Barack Obama’s first term in office, former Chinese Premier Wen Jiabao told reporters that China has “lent a huge amount of money to the U.S.” and “of course we are concerned about the safety of our assets. To be honest, I am definitely a little worried.”
China was the largest holder of U.S. sovereign debt at that time, too. Their Treasury holdings are greater now than they were then.
China faces limits to how much it can do.
While China can certainly diversify its reserves, the People’s Bank of China (PBOC) does have to deal with certain constraints, said London-based Capital Economics.
“The PBOC may be able to find better returns elsewhere, but the ability to liquidate assets at that sort of rate (that’s possible with U.S. Treasuries) is a powerful draw. This explains why the share of reserves allocated to the U.S. market appears to have been stable over time,” the research house said in a note on Wednesday.
China’s foreign exchange reserves are growing again, so Beijing will have few options but to buy U.S. Treasury bonds, added Mark Jolley, a strategist at CCB International Securities. China needs to invest its foreign exchange reserves in order to help it manage the value of its own currency, the yuan.