China: Mnuchin-Xiao Meeting on Bonds, FX and Rates

Published on February 6, 2018

In a barely covered but important development, China’s Minister of Finance Xiao Jie met with his counterpart, US Treasury Secretary Steven Mnuchin, last week on Thursday, February 1, in Washington, DC.

*** For all the market focus on trade wars with Beijing and the perceived threat of the dumping of US bonds in return, the meeting between Mnuchin and Xiao was a low-key affair, with no signs whatsoever of any such saber rattling – or in the words of a Beijing source, it was “just a regular meeting.” Indeed, the conversation focused entirely on issues of financial cooperation and mutual concern, including the outlook for US fiscal policy, with Xiao explicitly offering all – important (to markets) reassurances of no shift on China’s exposure to US rates and bond holdings. ***

*** From what we understand, Xiao relayed to Mnuchin that Beijing is closely monitoring US Treasury yields, especially with the 10-year yield hitting 2.8% and the 30-year above 3%. And while the Chinese Finance Ministry forecasts are for US yields to continue to rise through 2018 and 2019, Xiao reportedly assured Mnuchin that in the interest of ensuring the smooth development of Sino-US relations – especially on economic and trade relations – China will continue to hold US bonds, “steadily.” ***

*** In a separate but we believe clearly related development, a senior Chinese official on the sidelines of UK Prime Minister Theresa May’s visit to China last week sent a clear warning we are told over the pace of appreciation of the Chinese Renminbi. The RMB, it was noted, has appreciated an unprecedented 3.5% in January against the Dollar. If Sino-US trade relations remain (relatively) stable, but the dollar were to continue to weaken, the currency, Chinese officials predict, could now rise by a total of 5% this year, instead of the originally expected 3%. But if the strong upside trend for the CNY were to continue, the PBoC, we were warned, will “appropriately” intervene. ***

Any FX intervention aimed at stemming the strength of the RMB, of course, would entail net new purchases of US securities, and not the dreaded sales.

A (Deliberately) Low-Key Meeting

On the Chinese side, the main concerns and questions raised at last week’s meeting between the two finance ministers revolved around the looming debt ceiling and the possibility of another US government shutdown, the Trump tax cuts and any details of the upcoming infrastructure plan, and included the discussion noted above of China’s US Treasury bond holdings and purchases.  The two sides also agreed to consider a bilateral economic dialogue in either April or May.

According to post-meeting briefings, Chinese officials walked away from the meeting believing the Treasury’s cash reserves could run out now sooner than they had initially expected. And if the US debt ceiling were not to be raised over $20.4 trillion by the first half of March, the government would not be able to pay its obligations, forcing yet another shutdown.

While this is not news to markets – and indeed there are signs that Congress – perhaps shaken by the latest violent retracements in the stock markets – may be finally taking the matter in hand, it is a telling reflection of Beijing’s keen focus on the risk and potential impact of this debt ceiling debate not just on rates, but on the value of the US dollar as well.

MOF officials were finally left skeptical about the prospects for Trump’s $1.5 trillion infrastructure plan, despite the subsequent announcement from the White House of an imminent roll out on February 12, the main reason being skepticism over the administration’s ability to find sources of revenue for the plan. But that is a question, perhaps, for another day.

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