It might be easy to conclude China’s unprecedented retreat from Treasuries is bad news for America.
After all, as the biggest overseas creditor to the U.S., China has bankrolled hundreds of billions of dollars in deficit spending, particularly since the financial crisis. And that voracious appetite for Treasuries in recent years has been key in keeping America’s funding costs in check, even as the market for U.S. government debt ballooned to a record $13.2 trillion.
Yet for many debt investors, there’s little reason for alarm.
While there’s no denying that China’s selling may dent demand for Treasuries in the near term, the fact the nation is raising hundreds of billions of dollars to support its flagging economy and stem capital flight is raising deeper questions about whether global growth itself is at risk. That’s likely to bolster the haven appeal of U.S. debt over the long haul, State Street Corp. and BlackRock Inc. say. Any let up in Chinese demand is being met with record buying by domestic mutual funds, which has helped to contain U.S. borrowing costs.
“You have China running down reserves and Treasuries are a big portion of reserves, but even with that we still think the weight of support” will boost demand for U.S. debt, said Lee Ferridge, the head of macro strategy for North America at State Street, which oversees $2.4 trillion. The question is “if China slows, where does growth come from. That’s what’s been worrying a lot of people coming into 2016.”
Those concerns are playing out in Treasuries as a stunning meltdown in Chinese equities to start the year convulsed financial markets around the world and prompted investors to pour into the safest assets. Yields of U.S. 10-year notes were at 2.18 percent today, after closing out 2015 at 2.27 percent.
Demand has remained resilient, despite warnings that selling pressure from China, which holds about $1.4 trillion of U.S. government debt as part of its foreign-currency reserves, would undermine America’s ability to borrow and refinance its obligations. Over the years, both Republican and Democratic politicians have repeatedly voiced concern that China’s ownership of U.S. debt poses a threat to America’s independence.
Based on the Treasury Department’s latest figures, China has reduced its holdings by about $187 billion in the first 10 months of 2015. The tally includes Belgium, which analysts say is home to Chinese custodial accounts. If that pattern holds, it would be the first time the Asian nation has reduced its stake in Treasuries on an annual basis.
All signs suggest that’s just what is happening. In December, the People’s Bank of China burned a record amount of its foreign-exchange reserves to stem a plummet in the yuan as overseas investment — which fueled China’s two-decade long boom — exits the country. Last week, traders also saw signs in the swaps market of possible Treasuries selling by China.
The People’s Bank of China didn’t reply to a fax seeking comment.
The big draw-down in reserves and the surprise weakening of the yuan is fueling concern the slowdown in China, one of the biggest engines of global growth, is even worse than most anticipate and will drag down the rest of the world. In December, economists surveyed by Bloomberg said China’s economy, second only to the U.S. in size, will grow 6.5 percent this year, which would be the least since 1990.
To BlackRock, that takeaway is far more important to debt investors than any temporary supply-demand issues raised by China’s sales of Treasuries.
“You have these technical factors, but that’s losing sight of the forest for the trees,” said Jeffrey Rosenberg, the chief investment strategist for fixed income at BlackRock, which oversees $4.5 trillion. “If China’s a big seller of Treasuries, and that gets everyone else thinking it’s massively deflationary, people will get fearful and go to quality. That’s where the demand for Treasuries will come from.”
So far, U.S. money managers have stepped in to fill the void. They bought 42 percent of the notes and bonds sold at U.S. debt auctions last year, the highest share since the Treasury started breaking out the data five years ago and more than twice the long-term average.
American investors of all types are also boosting their holdings of Treasuries by the greatest percentage since the financial crisis erupted in 2008, data compiled by Bloomberg show.
The lack of risk appetite may keep Treasuries in demand well into 2016. Jitters over China, the rout in equities and tumbling oil prices are already dimming the prospects for growth and inflation in the U.S., and convincing traders the Federal Reserve will have to go easy on interest rates this year.
“The Fed’s saying ‘we can do it,’ but the market is basically wondering how realistic” that is, said Bret Barker, a bond manager at TCW Group Inc., which oversees about $180 billion. “You’re seeing this ripple effect and people are worried.”
Whatever happens in China, the chances are remote the country will dump its U.S. government debt. The Asian nation owns so much already that a wholesale liquidation of Treasuries would only hurt its own finances.
For JPMorgan Asset Management’s David Tan, turmoil in China and elsewhere in the world will only serve to support demand for Treasuries.
“You’re going to have a distinct lack of inflationary pressure and you’ve got so many pockets of stress in so many countries,” said Tan, the global head of rates at JPMorgan Asset, which oversees more than $1.7 trillion. “What we absolutely do not see is a bear market in Treasuries this year.”