Fear Mongering in China’s Sale of U.S. Debt
China unloaded a record $188 billion of U.S. Treasuries last year. By Dan Weil
Foreign selling of U.S. Treasuries has put some market observers in a tizzy.
But after Bloomberg ran a headline in February that “America’s Biggest Creditors Dump Treasuries in Warning to Trump,” some money managers and analysts wondered if the market’s concern might be overstated. Foreign central banks and private investors sold $343 billion of Treasuries last year, while purchasing $422 billion of U.S. government agency debt (mostly mortgage securities) and corporate bonds, according to data from the Treasury Department.
“There’s an overwhelming emphasis on central banks, particularly China’s, selling a significant amount of Treasuries,” says David Ader, chief macro strategist for Informa Financial Intelligence, an investment consulting firm. “But that’s just one side of the coin. People are saying foreigners don’t like U.S. debt anymore, but foreign investors still like the U.S. It’s just an allocation decision.”
Most of the selling was done by central banks, with China being the biggest seller last year as it unloaded a record $188 billion of U.S. Treasuries, leaving its holdings at a seven-year low of $1.06 trillion, according to Treasury Department data. China and other emerging-markets central banks, including Turkey, Mexico, and Malaysia, sold the debt to defend their currencies, which were under assault in 2015 and 2016.
There’s been a lot of “fear mongering” surrounding Chinese Treasury sales, says Karim Ahamed, senior investment adviser at HPM Partners. But if the yuan continues to decline, that may discourage the People’s Bank of China from selling Treasuries because it will want to hold more valuable currencies. Plus, Ader adds, signs of an improving Chinese economy this year may diminish a need to raise cash through the sale of Treasuries.
“Treasuries still look attractive,” says Ahamed, noting that U.S. government debt is yielding more than government bonds issued by Germany and Japan. The ten-year Treasury note yielded about 2.5 percent on March 20, compared with 0.44 percent for ten-year German Bunds and 0.07 percent for ten-year Japanese government bonds.
And while some of the Treasury selling at the end of last year was a reaction to newly elected U.S. President Donald Trump and his anticipated economic policy, both the U.S. economic story and the yield advantage of U.S. bonds over foreign bonds are strong enough to draw foreign investors, analysts and money managers say.
The selling “was part and parcel of a portfolio rebalancing, given the fiscal agenda of Trump,” says David Gilmore, a partner at currency consulting firm Foreign Exchange Analytics. “The risk for inflation and lower bond prices were pretty evident.”
Meanwhile, higher yields on U.S. agency and corporate bonds are attracting foreign investors, with the Bloomberg Barclays corporate bond index yielding 3.5 percent and the Fannie Mae index at 3.12 percent on March 15.
“Private foreign investors are saying, ‘We very much like U.S. interest rates,’” says Ader.
While some observers suggest that foreign investors have the U.S. over a barrel because they own 43 percent of Treasuries outstanding, Ahamed doesn’t see it that way. “If you look around the world, we’re in considerably better economic shape than many other countries,” he says. “We’re pretty well placed, especially compared to Europe and Japan, where there is a need for more easing.”
What could spark further foreign central bank selling of Treasuries is faster than expected U.S. economic growth, leading to more rapid interest rate increases by the Federal Reserve, says Robert Tipp, chief investment strategist at PGIM Fixed Income. That would likely push the dollar higher, forcing central banks to unload Treasuries to stem the decline in their currencies.
Private investors may act differently, though. Rising U.S. rates would make Treasury yields more attractive, and a rising dollar would suppress U.S. inflation and make Treasury holdings more valuable in foreign currencies. “There’s a compelling case for private investors to invest in the U.S. under those circumstances,” Ader says.
Even if a rising dollar forces central banks to dump Treasuries, that selling could be more than offset by investors flocking to the safe haven debt should market sentiment sour. “A surging dollar can create a risk-off environment where Treasuries rally even in the face of forced foreign central bank selling,” notes Tipp.
In any case, foreign activity alone doesn’t determine the path of U.S. yields, which fell for the first ten months of last year despite foreign Treasury sales. “U.S. private investors have stepped in when China and Japan are unloading,” Ahamed says. “That suggests pension funds are seeing yields start to rise; they are looking at that as an opportunity to purchase Treasuries.”
And it’s not just U.S. institutional investors diving into Treasuries. Retail investors are buying the government debt both for yield and the safe haven it provides, he says: “Normally, retail is seen as stupid money, but perhaps this is a more prudent move.”