China's Back at the Treasury Counter

The gap between shorter and longer-term U.S. government debt is poised to shrink.

It's significant that China is buying U.S. Treasuries again.

It means that the path of least resistance for benchmark U.S. government bond yields is lower, not higher. And it means that the gap between shorter and longer-term U.S. government debt will more likely contract than widen.

According to Bloomberg News on Tuesday, China is preparing to buy more Treasuries as it seeks to prove to the world that it and its currency are in good shape. This is a reversal from last year, when the world's second-biggest economy sold a greater amount of Treasuries than ever before.

China has domestic reasons for its actions. Last year, it needed cash to stabilize its currency and help bolster its financial system. It is still providing a good deal of support to its banks, but the nation has enjoyed more stability in the yuan and lighter capital outflows. So it's a good time to show strength by building up foreign-currency reserves.

“Buying U.S. bonds will help boost confidence," Tommy Ong, managing director for treasury and markets at DBS Hong Kong Ltd., said in the Bloomberg News article. "Officials want to show that any anxiety about yuan weakness or devaluation was excessive."

The nation has already purchased Treasuries for several months in a row, activity that has coincided with a decline in both benchmark yields and a narrowing of the U.S. yield curve. Perhaps this is coincidental; during that period, investors domestically started worrying about the degree to which President Donald Trump could truly stimulate growth, especially as he failed to make real progress on some of his main initiatives.

But China is the gorilla in the room. It was the biggest foreign owner of U.S. government debt until last year, when Japan overtook it. It has a monster balance sheet and the ability to absolutely distort markets if it makes up its mind to buy or sell in mass. Last year, as the nation sold nearly $200 billion of its Treasury holdings, yields on the debt rose.

U.S. Treasury yields are now at the lowest rates of 2017, and a widely examined gap between 2-year and 30-year rates has reached the narrowest since September, before the contentious U.S. election. The Federal Reserve is trying to push up benchmark rates and will most likely kick up overnight rates by a quarter of a percentage point next week.

If China is any guide, that move may have little effect on longer-term borrowing costs as yields stabilize or fall further. 

Of course, China alone can't support or sink the $13.9 trillion U.S. government-debt market. But it's a significant influence. It sets a tone, especially when trading volumes are sagging and investors are struggling to have conviction amid continuing political turmoil.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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