- Report claims China could halt Treasuries accumulation
- Speculative story sparks major move in USD
- 'De-dollarisation', CNY key issues to watch in China
By John J Hardy
A Bloomberg story citing sources-in-the-know suggests that Chinese officials responsible for reviewing China’s FX holdings recommend a halt to accumulating US Treasuries. This set off a flurry of across-the-board USD selling, and here we look at a couple of reasons why the market sold the USD on the story.
The story was met by a flurry of USD selling
on reports that Chinese officials have apparently recommended that US Treasuries look less attractive relative to other assets; the report also claimed that "trade tensions with the US may provide a reason to slow or stop buying American debt."
There are myriad reasons why the story, if true (it is very important to watch now for follow-up information or official denials/"non-denials"), is important. It may in fact trigger a USD rout, depending on what is really going on. Below are some thoughts on why the immediate market reaction was so forceful, but let’s keep in mind that if this story is denied, markets could quickly go back to square one... and then some (USD grabbing back much of lost ground).
The People's Bank of China, Beijing: Is China really calling a halt to Treasury accumulation?Photo: testing / Shutterstock.com
The US already came into this year very vulnerable on the fiscal front, as the deficit was widening and will be made very significantly worse by the newly passed tax reforms. The deficit shortfall could push close to $1 trillion this year, and this in a year of economic expansion! So any Treasury buyer supposedly announcing that they are stepping away from accumulating Treasuries is negative for the USD on balance if true.
Also, the USD was already rather shaky versus the Japanese yen on recent news out of Japan that the Bank of Japan failed to grow its balance sheet in December and is buying fewer long Japanese government bonds at its next round of purchases than it has previously. Many believe that this points to an eventual BoJ policy normalisation and again, USDJPY had already corrected significantly lower before this China story broke.
This would add to the global "central bank policy convergence" narrative, the idea that even the BoJ is moving away from accommodation and may eventually play catch-up with the Federal Reserve, just as 2017 was the year the euro rose on the prediction that the European Central Bank would eventually taper.
USDJPY: The dollar lost around 40 pips versus JPY on the release of the news
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Source: Saxo Bank
China is supposedly looking to "de-dollarise" its trade relationships to as large a degree as possible. The more it can succeed in doing so, the more it can reduce its USD reserve holdings (and USD is generally held as US Treasuries) as it won’t need these for portions of its trade. On that note, some might say that this is a shot across the US’ bow on any risk that the Trump administration is set to confront China with aggressive trade policies (effectively, the officials make the point of linking it with US trade policy anyway).
This is a stark reminder that there is a long, ongoing effort underway to “de-dollarise” China’s trade relationships and make it less reliant on the USD.
Before President Trump won the election, China was divesting itself of Treasuries in a slow fashion after it changed its FX regime starting in August 2015, allowing the USDCNY to rise as the CNY devalued with US Treasury reserve holdings levelling out in 2015 (as Chinese total reserves were in a freefall) and then actually falling for much of 2016.
The chief reason for the decline in Chinese holdings of US Treasuries over this period was likely that it was mobilising USD reserves (selling US Treasuries) to intervene in the FX market and avoid an even more rapid decline in the CNY. But after the November 2016 US election, China apparently had a change of heart regarding its FX regime and began accumulating Treasuries again, having added about $10 billion/month to its supply over the last year.
The rise in Treasuries dovetailed with a rise in the CNY from USDCNY 6.95 to below 6.50 at one point.
Or is it all about CNY?
An alternative theory 180 degrees against the de-dollarization and trade war narrative holds that China’s real concern is that the move to apparently halt the USDCNY slide at 6.50 could mean that capital hot money outflows become a risk again and it will need to sell US Treasury holdings to defend the yuan against excessive weakening (at every signal, it seems speculators take the ball and try to front-run China’s policy intentions).
Again, some might point to China’s accumulation of Treasuries in 2017 as part and parcel of the reason the USDCNY rate fell during the year as China had to brake the CNY’s rise with interventions and USD buying.
Why China apparently wants the USDCNY to stop falling at 6.50 is another question – is it merely to swat carry traders who had leveraged USDCNY short positions, or because it now wants to weaken the CNY again as a shot across the bow to Washington?
Or is it to avoid domestic deflationary pressures via a CNY devaluation as it plans on starting to deleverage its economy after the February 16 Lunar New Year celebrations?
We won’t know, but we will watch for further signals from China even more closely than ever.
— Edited by Michael McKenna
John J Hardy is head of FX strategy at Saxo Bank