Debt Market's China Syndrome
China is sending ripples through the world’s biggest, most-liquid debt market, but not in an expected way.
Instead of prices rising in the U.S. Treasury market, a traditional haven amid turmoil, China’s confusing policies caused this debt to lose value on Thursday. Here’s why: The more money China ineffectively throws at its problems, the more foreign currency reserves it will be forced to sell. In other words, China will probably be a considerable seller of U.S. and European sovereign debt for the foreseeable future.
That doesn’t bode well for Treasuries. On Thursday, as stock traders worldwide ran for the exits, there was a selloff in Treasuries, with yields on 10-year Treasuries rising to 2.2 percent, their first increase of 2016, before reversing course later in the day. European sovereign debt markets that also serve as havens experienced a similar phenomenon, with the bonds broadly losing value.
While China’s selling won’t necessarily lead to a sudden spike in U.S. government debt yields, its activities have propped up yields that would otherwise be much lower. If it weren’t for China’s sales of Treasuries, yields on the 10-year notes would probably be below 2 percent, said Jim Bianco, president of Bianco Research.
China owns huge stockpiles of U.S. and European assets as part of its foreign-currency reserves. And it’s selling them at an accelerating clip. China’s foreign-exchange reserves slid more than forecast in December, shrinking by a record $108 billion, to $3.33 trillion, according to the People’s Bank of China.
Meanwhile, China’s experiment of reducing stock volatility with circuit breakers was a complete failure that had the opposite effect, simply igniting panic and prompting investors to sell as quickly as possible before markets shut down. Who owns many of these stocks? Wealthy Chinese citizens, who are withdrawing their cash from the local economy at an accelerating pace.
This capital flight has prompted China to spend more of its reserves to bolster its currency's value.
While there’s been a great deal of focus on equities that are reeling in the wake of China’s flat-footed policies, the effect on sovereign debt markets is also significant. Going forward, U.S. and European sovereign debt will struggle to post appreciable gains unless China gets its economy under control. And if it manages to do so, that will push traders away from havens and into riskier securities.
For now, China’s expensive attempts to calm market turmoil makes medium-term U.S. government debt less attractive, not more.
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