Download Should We Worry about China Dumping US Treasuries?

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
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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
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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
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