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Jitters over China's waning taste for T-biIIs
By Robert Cookson and Michael Mackenzie
Published: February 18 2010 18:16 | Last updated: February 18 2010 19:02
Ìf there is one thing that gets investors twitchy, it is the fear that China is Iosing its appetite for US government
bonds.
As the biggest and most liquid pool of assets in the world, the US Treasury market l ies
at the heart of the global financial system and allows the American government to
finance its trillion-dollar budget deficits. Until recently, China has been the largest
foreign official holder of US debt.
That is why the latest release of Treasury Ìnternational Capital (Tic) data, showing
that China's holdings of Treasuries fell by a record amount in December, has caused
something of a stir.
China's holdings fell by $34.2bn to $755.4bn from the previous month, prompting
renewed jitters that the country was diversifying from Treasuries over fears about their
future value.
China's holdings have fallen from a peak of $801.5bn in May 2009, and the data come at a time of heightened
political friction between Beijing and Washington over issues such as Barack Obama'smeeting with the DaIai
Lama, US weapons saIes to Taiwan, and pressure on China to revalue the renminbi.
"These developments require monitoring because they could cause China to become evenless enthusiastic buyers
of US Treasuries,¨ says Yasunari Ueno, chief economist at Mizuho Securities in Tokyo. "A key issue now is how
China will act in 2010 in light of the deteriorating bilateral relationship with theUS.¨
China may have indeed started to rebalance its foreign reserve portfolio from US Treasuries, he says, having piled
into the asset class after the collapse of Lehman Brothers in September 2008. But most analysts, including Mr Ueno,
believe the December dip in China's holdings of US Treasuries more likely has more mundane explanations. They
also caution against reading too much into the Tic data, which is prone to big monthly swings and is subject to
so-called transactional bias.
Tic data is further clouded as the true holdings of Asian central banks such as the People's Bank of China are
obscured by their use of custodians in big financial centres offshore.
Dealers believe China may have made significant purchases in the past year through Hong Kong and London.
Treasury holdings by Hong Kong rose to $152.9bn in December ÷ up from $77.2bn in Dec2008.
Meanwhile, UK holdings of Treasuries have also surged, reaching $302.5bn in December, from $230.1bn in
October.
Ìn terms of China's portfolio of Treasuries in the Tic report, the December data show a further big reduction in
holdings of short-dated bills and buying of longer-dated coupon debt. China's T-billholdings dropped by $38.8bn in
December while its holdings of notes rose by $4.6bn.
Rather than selling any of its holdings, China appears to have let the bills mature and then used some of the
proceeds to buy longer-dated coupons, analysts say. Extending its purchases along the yield curve is, partly, a sign
of China's confidence in the US government's ability to service its debt. The Tic data show that China has not
diversified into US equities or corporate bonds.
During the financial crisis, China built up holdings of short-dated T-bills from $14bn in mid-2008 to $210bn by May
2009 and they are now back around $70bn.
"The latest data is consistent with them shrinking the T-bill mountain rapidly, although there is more to come, as the
likely underlying desirable holdings of T-bills is probably nearer $20bn,¨ says AlanRuskin, strategist at RBS
Securities.
"China is simply fine tuning its portfolio and as US banks and consumers continue deleveraging, there will be
enough domestic demand to buy Treasuries,¨ says John Brady, senior vice-president ofglobal interest rates at MF
Global.
Mr Ueno says the most probable cause of China's decline in Treasury purchases, is si mply that the country's foreign
reserves grew at a slower pace in December. Julian Jessop, economist at Capital Economics, predicts that
December's Tic data represent a brief pause before China's purchases of Treasuries resume.
And even if China is shifting out of US Treasuries, it would not necessarily cause trouble in the market as long as
other buyers step into the breach. Ìndeed, US Treasury yields remain well inside last summer's peaks as other
countries have stepped up their buying.
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Significantly, Japan overtook China as the biggest foreign holder of US Treasuries i n December, and its monthly
purchases have been consistently rising since May. The country, which is seen as having a more stable relationship
with the US, held $768.8bn of Treasuries in December, an increase of $142.8bn from t he previous year. Analysts
see little rationale for China to reduce its Treasury holdings dramatically, given that such a move would be likely to
have severe consequences for Beijing.
Ìf Chinese demand for Treasuries disappeared and it started selling, US interest rat es would rise, analysts say. This
could throttle a US economic recovery, damage Chinese exports, and also reduce the value of China's existing vast
holdings of Treasuries as yields rose and prices fell, damaging a key plank of its currency reserves.
Moreover, China's currency link with the US dollar entails there is a limit to how f ar they can diversify their foreign
reserves.
"So long as China's currency is pegged to the US dollar, they will need to recycle their trade surplus dollars back
into US assets,¨ says Gerald Lucas, senior investment adviser at Deutsche Bank.
Which is yet another reason why Tic data is being closely watched. Ìf the latest numbers mark the beginnings of a
diversification by China away from US Treasuries and other dollar assets, a widely speculated rise in the value of
the renminbi against the dollar is on the cards.
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