What is behind the 40% drop in China's U.S. Treasury holdings?
Market players see Beijing selling American debt to prop up the yuan
TOKYO -- China continues to pare its holdings of U.S. Treasurys, arousing market speculations over its motives. The country's stockpile of U.S. government debt hit the lowest level in 14 years at the end of August, with the pace of decline accelerating.
Some analysts said Chinese monetary authorities are leading the move to shore up the yuan, while others blame it for a recent bond rout in the U.S.
"Maybe China is behind the rise in U.S. long rates," said Apollo Global Management economist Torsten Slok in a blog posted in early October, when yields on long-term U.S. bonds reached a 16-year high. A chart displayed with the comment showed China's Treasury holdings falling steadily after peaking in 2013.
The balance of U.S. Treasurys held by China totaled $805.4 billion in August, down 40% from a decade earlier, according to data from the U.S. Treasury Department.
China once actively bought the securities with its ample foreign exchange reserves, becoming the second-biggest foreign investor in U.S. Treasurys after Japan. Given the size of its holdings, China's selling could roil U.S. bond prices, pushing up interest rates.
Not everyone, however, agrees with Slok's views, contending that China could just as easily move its holdings to overseas custodians without selling them. Yet many analysts focus on the decline in the country's Treasury balance as a sign of Beijing's strong determination to defend its own currency.
China is facing serious capital flight caused by rising concern about its economic growth and debt burden. In September, capital outflows reached $75 billion, the biggest such monthly amount since 2016, according to an estimate by Goldman Sachs. This exerts strong downward pressure on the yuan, which now trades at around 7.3 against the dollar, the lowest since 2007.
"China's state-run banks likely dumped the dollar around the [Oct. 1] National Day," said a currency trader at a foreign bank, echoing the views of his peers. It appears that Chinese authorities urged state-run banks to shore up the yuan against dollars and they responded by selling Treasurys to raise needed funds.
Beijing has spent hundreds of billions of dollars out of its foreign exchange reserves on market interventions since 2015, when its devaluation of the yuan led to declines both in stock and currency prices. Eager to maintain the current level of foreign reserve balances, Beijing may have pushed state-owned lenders to support the yuan on its behalf, according to analysts.
The yuan's daily reference rates announced by the People's Bank of China show the sense of crisis being felt by authorities. While the gap between the reference rate and the market value has widened to a record level, the official midpoint remains pegged at 7.17 to the dollar since mid-September. As China allows the yuan to fluctuate only within 2% on either side of the midpoint, it looks as if the country has reverted to a fixed-rate system.
Taking advantage of the country's lower interest rates spurred by monetary easing, some speculators engage in carry trade by borrowing in yuan and converting the money into currencies with higher interest rates. Goldman Sachs has proposed clients use borrowed yuan to fund bets on higher-yielding currencies like the Brazilian real and other South American money.
As speculators seek profits by selling the yuan to buy other currencies, an increase in carry trade could further weaken the Chinese currency. Many analysts expect that if such speculative trading increases, Chinese authorities will have no choice but to step in to bolster the yuan -- possibly by unloading Treasurys.
However, the country's foreign currency reserves -- the source of Treasury purchases -- are unlikely to increase as in the past as export growth slows and the amount of foreign investment declines. Efforts by Western countries to de-risk economic ties with China have only begun to take effect.
If China continues to trim its Treasury holdings, market players may see it as a factor pushing up bond yields and thus as a matter of concern for the U.S. Federal Reserve. The unsteady Chinese economy has added yet another unpredictable variable to global financial markets.