We have received a number of queries around an article in the financial news media this morning reporting “unnamed sources familiar with the matter” as saying Chinese officials have recommended slowing or halting purchases of U.S. Treasuries for a variety of reasons.
*** We do not believe there has been a policy decision in Beijing to suddenly or substantially cut the People’s Bank of China’s US Treasury purchases this year. Chinese policymakers are certainly cautious about the outlook for treasuries in light of their expectations for three rate hikes by the Federal Reserve this year. But maintaining currency stability and avoiding a jarring currency shock remains a highest priority. ***
Addressing Three Questions
Here are our initial comments on the three main elements of the article as we look further into what – if any – changes the PBOC may actually implement in its FX reserve and foreign bond holding strategy over the coming year.
1- Are Chinese economic policymakers cautious on US Treasuries? Yes, absolutely. We understand that last week, on January 5, China’s Central Financial Leading Group (CFLG) reported to the Politburo of the Communist Party of China Central Committee they believe the Federal Reserve could hike three times this year. But that simply mirrors the Fed’s December Summary of Economic Projections 2018 rate dot plot (at least for now), so it is not exactly earth shattering info or analysis for that matter.
2- Will China try to limit its proportion of net UST purchases in its reserves? Yes, although note that FX flows are now modestly positive, so the big trend for the last year has been for a net increase in foreign (including US) bond holdings.
3- Will China cut net UST purchases to zero, including as retaliation on trade in addition to caution over the direction of US rates? Cutting net purchases in 2018 to zero is highly improbable, especially in this FX/flows environment. Chinese officials see growth as basically solid, 6.7 – 6.9% this year, and will seek a continued, stable CNY, and certainly will not create a potential “own goal” or “black swan” FX market event.
What’s more, from what we understand there is a standing financial cooperation agreement between Beijing and Washington that the PBOC will notify UST in advance if it decides to change its purchases by a material amount – the exact threshold eludes us at this minute – and we have heard nothing along those lines.
China HAS been trying to tamp back US Treasuries as a proportion of its holdings for as long as we can remember, albeit with limited success. Unfortunately for Beijing, its rare success on that front has been when the Renminbi was under pressure and they have had to conduct massive interventions selling USD and buying the CNY.
So for example in 2016, they DID cut net holdings of Treasuries by around $190 billion, but that again was due mainly to interventions and fighting FX outflows, and was part and parcel of a net decline of foreign bond holdings for thirteen quarters, about three years, which also corresponds to a weakening CNY for three years from 2014 through 2016.
On the other hand, in 2017, there was a modest increase in both total foreign bond and in US treasury holdings, as the FX markets essentially stabilized, and outflows turned into modest net inflows. Why Beijing might want to jeopardize that stability with a sudden, and major, policy shift we frankly don’t see, even though the basic, and more nuanced, directionality in the reporting we agree is right (they are, understandably, cautious on the outlook for UST this year).
As of the end of Q3 last year, US Treasuries constituted around 62% of China’s foreign government bond holdings, around $1 trillion out of $1.6 trillion held in bonds of major foreign countries, the exact breakdown numbers for which are confidential. With the RMB continuing through the fourth quarter of last year and the turn of the year basically stable to strong, the net flows have also continued basically towards, not against, added purchases of foreign bonds. That specifically includes US treasuries, even if the PBOC (continues) to try to manage the proportion of net holdings in UST as a matter of general reserve management.
So we are skeptical there has been a policy decision made in Beijing in recent days to suddenly cut all US treasury purchases. We do agree there certainly is some caution to Beijing’s outlook for US Treasuries – we have heard that often on various occasions – and so all else being equal there likely will, as there has been in the past, be an effort to be judicious in further net purchases of US securities.