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FIXED-INCOMEINSIGHTS ShouldWeWorryaboutChinaDumpingU.S.Treasuries? March31,2017 ZaneE.Brown Partner,FixedIncomeStrategist 597Views TradeandgeopoliticaltensionshavespurredinvestorconcernsthatChinamay unloadallorpartofitsholdingsofU.S.Treasuriestotaling$1.1trillion. InBrief TradeandgeopoliticaltensionsbetweenChinaandtheUnitedStateshaveraisedconcerns thatChinamaysellallorpartof itsmassiveholdingsof U.S.Treasurysecuritiesinresponse todevelopmentsthatBeijingconsidersunf avorabletoit. Alarge-scaledisposalof TreasuriesbyChinacouldleadtonegativeeconomicandmarket consequencesworldwide,spurredbyaspikeinU.S.interestratesandabigdropintheU.S. dollar. Itseemslikely,though,thatif thesellingprocessweretoleadtof inancialinstability,theU.S. FederalReserve(Fed)couldemergeasabuyerof Treasuriestocalmmarkets. If Chinaweretosellits$1.1trillionof Treasuriesinretaliationf orpressuref romWashingtonto balanceitstradesurplus,f orexample,theef f ectmaybetheoppositeof whatBeijingintends. Why?ForChina,sellingTreasuries—andtheU.S.currencyitreceivesasproceeds—could actuallyleadtotheundesirableoutcomesof weakeningtheU.S.dollarandstrengtheningthe yuan(therebymakingChineseexportsmoreexpensive). Meanwhile,ChinahasbecomelesscriticaltoU.S.Treasuryf inancing,asBeijing’sroleasa large-scalepurchaserof Treasurieshasdiminishedsomewhatoverthepastseveralyears. Thekeytakeaway—AnalysissuggeststhatinvestorfearsoverChina’sholdingsmaynotbe realized,andeveniftheywere,andtheFedtookmitigatingaction,theconsequenceslikely wouldbelessseverethaninitiallybelieved. China’senormousholdingsof U.S.Treasurysecuritiesof tenareperceivedasleveragethatcould beusedagainsttheUnitedStatestoextractabetternegotiatingpositiononavarietyof issues. TheperceptionthattheUnitedStatesisdependentuponChina’sf inancingof itsdebtimpliesa spikeinU.S.interestratesandpotentiallyaf allintheU.S.dollarwereChinatosuddenlystopits purchasesandsellitsholdings.Butissuchascenariolikelytounf old? Avarietyof recentdevelopmentsseemcapableof provokingsuchbehaviorinChina,f uelingf ears 1 of potentialf inancialinstability.AlthoughconcernsaboutthecurrentU.S.administration’sstance towardthe“oneChina”policyvis-à-visTaiwan,assessinga45%tarif f onimportedgoods,or characterizingBeijingasacurrencymanipulatorseemtohavebeenputaside,otherpotentialsore spotsremain.Adoptionof aso-calledborder-adjustmenttaxbytheUnitedStatescouldbe perceivedasanacross-the-boardtarif f onChinesegoods,andcouldprovokesomeretaliatory response. Tobesure,tradeisnottheonlyf lashpointf ortheU.S.-Chinarelationship.Disagreementsover developmentsintheSouthChinaSeaalsocouldresultinsomepushbackf romChina,ascouldthe impositionof additionalU.S.sanctionsonNorthKorea.Buttheissueof tradeisperhapsmost concerning,sinceChina’sholdingsof U.S.Treasuriesarerelatedtotradeandthetradeimbalance withChinaseemsapotentialtargetundertheWhiteHouse’s“AmericaFirst”policy. FedBackstop China’sU.S.Treasuryholdingsof $1.06trillion,accordingtotheU.S.TreasuryDepartment,are secondonlytoJapan.Liquidationof theentireportf oliowouldcertainlyaf f ectpricesof U.S. governmentsecuritiesaswellasthebroaderU.S.f ixed-incomemarket.EventhoughtheSecurities IndustryandFinancialMarketsAssociation(SIFMA)reportsthatdailyvolumeof U.S.Treasury securitiestradedduringthef irsttwomonthsof 2017averagedmorethan$540billion,$1.0trillion of salesoverashortperiodof timewouldmovemarkets. Itseemslikely,though,thatif thesellingprocessledtof inancialinstability,theU.S.Federal Reserve(Fed)couldemergeasabuyerof Treasuriestocalmmarkets.EvenwithouttheFedasa backstopbuyer,onceitbecameclearthatChina’ssaleshadconcluded,themarketimpactcould beshort-lived,whilethenegativef inancialconsequencesf orChinacouldbelong-lasting.Giventhe politicalandeconomicconsiderations,aretaliatorydumpingof Treasurysecuritiesseemsan unlikelypathf oraglobalpowerdependentontradewiththerestof theworldtopursue.Sucha movealsoignoresChina’sneedf orf oreignreservesandrelateddebtasacollectivetoolto managethevolatilityof itsowncurrency. If Chinaweretoselltheentiretyof itsholdingsof U.S.Treasurysecuritiesinretaliationtopressure f romWashingtontobalanceitstradesurplus,theef f ectmaybetheoppositeof whatitintends. ForBeijing,sellingTreasuries—andtheU.S.currencytheyreceiveasproceeds—weakensthe U.S.dollarandstrengthenstheyuan.Dollar-denominatedgoodsthenbecomemorecompetitive andyuan-denominatedgoodslesscompetitive,promotingareductionintradesurpluswiththe UnitedStates—theverytradeef f ectChinawouldstrivetoavoid.Itappears,then,thatChina’s leverageislesspowerf ul(althoughstillworthreckoningwith)thanmanyinvestorsf ear,andf rom China’sperspective,itmaybeimpracticaltoutilize. ReducedRole Italsomaybecomf ortingf orinvestorstonotethatoverthepastseveralyears,Chinahasbecome lesscriticaltoU.S.Treasuryf inancing.Itsabsoluteholdingshaverangedf rom$1.16trillionin2011 to$1.27trillionattheendof 2013andto$1.06trillionbyyear-end2016.However,becausethe levelof outstandingTreasurysecuritieshasgrown,f rom$8.9trillionin2011to$13.9trillionat year-end2016,China’srelativef inancingimportancehasgraduallydeclined.In2011,f orexample, Chinaheld13.1%of outstandingU.S.governmentdebt;byyear-end2016,itheldonly7.6%, accordingtoTreasuryandSIFMAstatistics. EvenwhenChinaheldalargerportionof U.S.debt,therisktoU.S.marketsmayhavebeenless thanf eared.In2012,U.S.secretaryof def enseLeonPanettaconductedanationalsecurity-risk assessmentof U.S.debtheldbyChinaandcametoconclusionssimilartothoseoutlinedabove. Theassessmentf oundthat“attemptingtouseU.S.Treasurysecuritiesasacoercivetoolwould havelimitedef f ectandlikelywoulddomoreharmtoChinathantotheUnitedStates.” Thecollectiveconclusionof theef f ectsof currencymovement,potentialChineselosses,and decliningrelativeimportancetoU.S.f inancingdonotsuggestChina’s“leverage”isunimportantin 2 termsof apotentialadverseef f ectonU.S.rates.Instead,analysissuggeststhatinvestorf ears overChina’sholdingsmaynotberealized,andif mitigatingactionistakenbytheFed, consequencesmaybelessseverethanmanyinvestorsf ear.Chinamayhaveothernegotiating toolsif tradewiththeUnitedStatesbecomesanissue,buttheinef f ectivenessof its“leverage” withU.S.Treasuryholdingsmayallowinvestorstoworrylessaboutthepotentialinterestrate consequencesof alargesaleof Beijing’sU.S.Treasuryportf olio. ANoteaboutRisk:Thevalueof investmentsinf ixed-incomesecuritieswillchangeasinterestratesf luctuateandin responsetomarketmovements.Generally,wheninterestratesrise,thepricesof debtsecuritiesf all,andwhen interestratesf all,pricesgenerallyrise.Bondsmayalsobesubjecttoothertypesof risk,suchascall,credit,liquidity, interest-rate,andgeneralmarketrisks.High-yieldsecurities,sometimescalledjunkbonds,carryincreasedrisksof pricevolatility,illiquidity,andthepossibilityof def aultinthetimelypaymentof interestandprincipal.Moreover,the specif iccollateralusedtosecurealoanmaydeclineinvalueorbecomeilliquid,whichwouldadverselyaf f ectthe loan’svalue.Longer-termdebtsecuritiesareusuallymoresensitivetointerest-ratechanges;thelongerthematurity of asecurity,thegreatertheef f ectachangeininterestratesislikelytohaveonitsprice.Lower-ratedbondsmaybe subjecttogreaterriskthanhigher-ratedbonds.Noinvestingstrategycanovercomeallmarketvolatilityorguarantee f utureresults.Statementsconcerningf inancialmarkettrendsarebasedoncurrentmarketconditions,whichwill f luctuate. Forecastsandprojectionsarebasedoncurrentmarketconditionsandaresubjecttochangewithoutnotice. Projectionsshouldnotbeconsideredaguarantee. Thisarticlemaycontainassumptionsthatare“f orward-lookingstatements,”whicharebasedoncertainassumptions of f utureevents.Actualeventsaredif f iculttopredictandmaydif f erf romthoseassumed.Therecanbenoassurance thatf orward-lookingstatementswillmaterializeorthatactualreturnsorresultswillnotbemateriallydif f erentf rom thosedescribedhere. Statementsconcerningf inancialmarkettrendsarebasedoncurrentmarketconditions,whichwillf luctuate.Thereis noguaranteethatmarketswillperf orminasimilarmannerundersimilarconditionsinthef uture. TreasuriesaredebtsecuritiesissuedbytheU.S.governmentandsecuredbyitsf ullf aithandcredit.Incomef rom Treasurysecuritiesisexemptf romstateandlocaltaxes.AlthoughU.S.governmentsecuritiesareguaranteedasto paymentsof interestandprincipal,theirmarketpricesarenotguaranteedandwillf luctuateinresponsetomarket movements. Theopinionsintheprecedingcommentaryareasofthedateofpublicationandaresubjecttochange.Additionally,the opinionsmaynotrepresenttheopinionsofthefirmasawhole.Thedocumentisnotintendedforuseasforecast,research orinvestmentadviceconcerninganyparticularinvestmentorthemarketsingeneral,anditisnotintendedtobelegaladvice ortaxadvice.ThisdocumentispreparedbasedoninformationLordAbbettdeemsreliable;however,LordAbbettdoesnot warranttheaccuracyandcompletenessoftheinformation. Investorsshouldcarefullyconsidertheinvestmentobjectives,risks,chargesandexpensesof theLordAbbettFunds.Thisandotherimportantinformationiscontainedinthefund's summaryprospectusand/orprospectus.Toobtainaprospectusorsummaryprospectusonany LordAbbettmutualfund,youcanclickhereorcontactyourinvestmentprofessionalorLord 3 AbbettDistributorLLCat888-522-2388.Readtheprospectuscarefullybeforeyouinvestor sendmoney. 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