China’s swift response to US President Donald Trump’s tariff proposals has again raised the specter of the largest foreign holder of US Treasuries running down its holdings.
The retaliation on Wednesday, which mooted levies on US$50 billion of US imports — the same value as Trump’s targets — took many by surprise.
Coming less than 12 hours after the US list, the move was “faster and a bit larger than expected,” Morgan Stanley economists said.
Ahead of the announcement, veteran analysts at Evercore ISI reflected the view of many, predicting no quick reprisal from China.
“Everything is in play right now, because we are in the initial stages of negotiating with both sides trying to play hardball,” Jack McIntyre, a fixed-income portfolio manager at Brandywine Global Investment Management in Philadelphia, said by e-mail, referring to the potential for China to cut its stock of Treasuries.
While McIntyre does not see that happening, he said his fund is positioned for the possibility, with underweight holdings of Treasuries relative to his benchmark.
Few China watchers would disagree with McIntyre that dumping the country’s vast holdings of Treasuries, officially standing at US$1.2 trillion, represents a nuclear option. After all, it would impose losses on China itself, and potentially cause mayhem in the world’s deepest bond market.
China declined the idea of abandoning US securities when Russia proposed the idea in 2008, former US secretary of the Treasury Henry Paulson has said.
China and Russia officially rejected Paulson’s account.
Yet, it is also true that Chinese Ambassador to the US Cui Tiankai (崔天凱) last month said “we’re looking at all options,” when asked about the potential for scaling back Treasuries buying.
He said financial markets would be among the casualties of US unilateral action.
Earlier rumblings came in January, when Bloomberg reported that officials reviewing China’s foreign exchange holdings recommended that purchases of Treasuries be slowed or stopped.
The official stock of Chinese holdings has come down from the middle of last year, even as the yuan appreciated. The size of the pile had soared in the past as officials acted to stem currency gains.
Chinese Vice Minister of Finance Zhu Guangyao (朱光耀) on Wednesday told a news conference in Beijing that China is a “responsible investor,” after he was asked whether the country would use its Treasury holdings to strike back against the US.
He reiterated comments by Chinese Premier Li Keqiang (李克強), who was quoted by state-run Xinhua news agency as saying last month that China manages its reserves in line with international capital market rules.
“China will probably reduce its net purchases of US Treasuries, as it has done from the beginning of the year — but more rapidly,” Natixis SA chief Asia-Pacific economist Alicia Garcia Herrero said in Hong Kong.
“This should push up longer-term yields in the US, but also widen spreads of investment-grade US credit,” she said by e-mail on Wednesday.
Garcia Herrero’s scenario is different than a move to sell Treasuries outright, which could prove destabilizing even to China.
A sudden plunge in the US dollar would cause yuan appreciation that could hit Chinese exports more powerfully than the tariff hikes proposed by Trump.
“If they were to do that, they could conceivably cause a panic-sell in the dollar” as other asset managers cut US debt holdings to limit losses, Macquarie Group Ltd global interest rates and currency strategist Thierry Wizman said in New York.
“It’s more likely that they would use the FX [foreign exchange] lever before they would use the interest rate lever,” he said, adding that even pursuing depreciation of the yuan is unlikely at this point.
Garcia Herrero also highlighted the potential for “staggered depreciation” in the yuan as a Chinese response to Trump.
In the Treasuries market, China would not have to actually sell in order to send shivers through trading, especially as the US government ramps up borrowing to fund a widening fiscal deficit.
“Even a simple headline, with China reminding the US of this number, could be a risk to US rates,” Deutsche Bank AG chief international economist Torsten Slok wrote in a note on Wednesday, referring to China’s more than US$1 trillion portfolio.
“This new risk adds to the already long list” of reasons to be wary of Treasuries, he wrote, from rising borrowing needs to upside risks for inflation.
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