A year after criticizing U.S. fiscal policy as “irresponsible,” China’s leaders are showing increasing confidence in President Barack Obama’s leadership of the American economy.
China boosted holdings of Treasury notes and bonds by 2.6 percent to $900.2 billion in March and April, after reducing its stake by 6.5 percent from November through February, the longest consecutive monthly declines in a decade, U.S. data released June 15 showed. The People’s Bank of China said June 19 that it will relax its 23-month lock on the yuan.
U.S. Senator Charles Schumer and Congressional leaders say the new foreign-exchange policy doesn’t go far enough to keep them from seeking laws to punish China for what they say are unfair trade practices. Regardless of the currency rate, China will continue to be a net buyer of U.S. debt, according to George Goncalves, head of interest-rate strategy at primary dealer Nomura Holdings Inc.
“It’s just bad economics to pretend we can fix the lives of middle class American workers by getting the Chinese to revalue its currency vis-a-vis the dollar -- it’s a horrible misconception,” Stephen Roach, chairman of Morgan Stanley Asia Ltd. said in a June 15 radio interview from Hong Kong with Tom Keene on Bloomberg Surveillance.
China’s $22.7 billion in Treasury purchases during March and April contributed to a $205.2 billion increase in total foreign holdings. That was the biggest gain since $211.3 billion in June and July of 2009.
Purchases in recent months have focused on longer-term debt, unlike in 2008, when most of the cash went into Treasury bills. China boosted its holdings by 18 percent in the 12 months through this April, with notes and bonds due in two years or more surging 46 percent.
By purchasing longer-term securities, China is helping keep U.S. borrowing costs near record lows, aiding companies and individuals as the U.S. economic recovery strengthens.
Long-term U.S. rates would be about a percentage point higher without foreign government and central bank buyers, according to studies done in 2006 and 2009 by Professors Francis and Veronica Warnock at the University of Virginia in Charlottesville, who researched the matter for the Federal Reserve.
Following the latest round of purchases, yields on 10-year Treasuries, the benchmark for everything from corporate bonds to mortgages, fell to 3.06 percent on May 25, the lowest since May 2009 and below the average 4.35 percent since the U.S. government began reporting foreign holdings of U.S. financial assets in March 2000. The 3.5 percent note due in May 2020 fell 14/32 to 101 28/32 today, pushing up the yield to 3.28 percent.
Treasuries are having their best year since 2003, returning 4.51 percent through June 18, according to Bank of America Merrill Lynch index data, as investors seek alternatives to Europe, where Greece and Spain had their credit ratings downgraded amid growing budget deficits. The Standard & Poor’s 500 Index of shares rose 0.22 percent this year.
“Obviously the financial crisis, the flight to quality, all that stuff explains this big drop in yields,” said Dominic Konstam, head of interest-rate strategy in New York at Deutsche Bank AG, one of the 18 primary dealers that are obligated to bid at Treasury auctions. “That doesn’t mean they’re not having an influence,” he said of foreign demand.
Longer-term debt is gaining in appeal as inflation slows. The consumer price index fell 0.2 percent in May, the biggest drop since December 2008, figures from the Labor Department on June 17 showed.
Fed policy makers meet this week and will likely keep their target rate for overnight loans between banks at a record low of zero to 0.25 percent, according to all 91 economists surveyed by Bloomberg. Treasuries due in 10 years yield 2.51 percentage points more than the federal funds rate, compared with average of 1.61 percentage points over the last decade.
Yields on U.S. corporate bonds average about 5.6 percent, down from last year’s high of 10.3 percent, Bank of America Merrill Lynch index data show. That saves a company $4.7 million in annual interest expected for every $100 million borrowed. The rate on 30-year fixed mortgages is 4.75 percent, near the all-time low of 4.71 percent reached in December, according to Freddie Mac.
China kept the yuan pegged around 6.83 per dollar since July 2008 as it steered the world’s third-largest economy through the global recession that followed the collapse of credit markets starting in late 2007.
The decision to increase “exchange-rate flexibility” was made after the economy improved, the central bank said in a statement on its website, without indicating a timeframe for the change. It ruled out a one-time revaluation, saying there is no basis for “large-scale appreciation,” and kept the yuan’s 0.5 percent daily trading band unchanged.
Pressure on Chinese leaders may intensify in coming days as finance ministers from the Group of 20 nations meet in Toronto on June 26-27. While not singling out China by name, Obama said in a letter to his G-20 counterparts on June 18 that “market- determined exchange rates are essential to global economic vitality.”
“This vague and limited statement of intentions is China’s typical response to pressure,” Schumer said in a statement. “Until there is more specific information about how quickly it will let its currency appreciate and by how much, we can have no good feeling that the Chinese will start playing by the rules.”
‘Multilateral Trade Deficit’
A draft bill introduced by Schumer, a Democrat from New York, in March would seek import duties to compensate for an undervalued currency and impose tariffs on the second-largest U.S. trading partner and biggest creditor. Schumer said Congress may still vote on the legislation. China’s trade surplus with the U.S. has increased 5.7 percent above the same period in 2009.
“If we don’t boost our national savings rate, with trillion dollar deficits as far as the eye can see, the Chinese piece of our multilateral trade deficit just goes somewhere else,” Roach said. “It goes to a higher-cost producer and that taxes the American people.”
China, which increased its holdings of Treasuries from $58.9 billion in 2000, was critical of U.S. fiscal and monetary policy heading into the G-20 meetings in London in April 2009.
The Fed’s decision to buy $300 billion of Treasuries was called “irresponsible” by Li Xiangyang, of the government-backed Chinese Academy of Social Sciences, because it could weaken the dollar. People’s Bank of China Governor Zhou Xiaochuan urged the International Monetary Fund to work on creating a “super-sovereign reserve currency” that would be stable and independent of individual nations.
“We have lent a massive amount of capital to the United States, and of course we are concerned about the security of our assets,” Chinese Premier Wen Jiabao said in March 2009 after Obama signed last year’s $862 billion stimulus package into law. “To speak truthfully, I do indeed have some worries.”
As the Chinese were expressing concerns, bond investors were becoming more pessimistic. Bank of America Merrill Lynch Index data show Treasuries lost 4.5 percent during the first half of 2009 as Obama increased the pace of borrowing to help fund the $700 billion Troubled Asset Relief Program and the fiscal-stimulus package.
China has bought at least $80 billion of U.S. government debt each year since 2005, the same year it allowed the value of the yuan to move daily within a 0.3 percent trading band.
The currency appreciated 21 percent against the dollar between July 2005 and August 2008. The yuan’s 12-month non-deliverable forwards rose 1.1 percent to 6.6425 per dollar today in Hong Kong, data compiled by Bloomberg show. The contracts reflect bets the currency will appreciate 2.3 percent in the next year.
“If history’s any guide they will keep buying,” Nomura’s Goncalves said. “Global imbalances don’t turn on a dime. We don’t know how robust this recovery is. There are only so many places China can put its money.”
In five of the last six years, China has made its largest purchases of U.S. debt in June, Treasury data show. The Treasury is selling $108 billion in two-, five- and seven-year notes over three days starting tomorrow.
“I don’t think it’s really in China’s economic interest to distance itself from its economic ties with the U.S.,” said Carl Lantz, head of interest-rate strategy in New York at primary dealer Credit Suisse Group AG. “We borrow pretty cheaply from them, we buy their goods. Our country, despite some of the turmoil, still offers deep and liquid capital markets.”