China, U.S. Treasuries and Temporary Truths

In a span of less than 24 hours, we went from a Bloomberg News report last week that China might reduce its exposure to U.S. Treasuries to China’s denial and claims of “fake news.” I suspect the original story and the denial had official backing, with the initial news viewed as a “temporary truth” that would dissipate like a Snapchat photo after a brief period of time to be replaced by a more convenient truth. That said, the run-up in Treasury yields before the news means that China may, in fact, have been hedging some of its portfolio holdings.

Yields have since gone up and the dollar down against the euro, suggesting the market believes there’s some merit to the notion that China wants to pull back from its massive holdings of U.S. financial assets. The thinking is, China is probably flirting with a bit of dollar-based asset selling not only in an attempt to strengthen its hand in trade negotiations, but also to get a better understanding of how these financial weapons would work. It’s the same reason you test nuclear weapons -- to see what they can do.