China continues to pare its holdings of US Treasuries,
leading to market speculations over its motives. The country's stockpile of US
government debt hit the lowest level in 14 years at the end of August 2023,
with the pace of decline accelerating.
Some analysts said Chinese monetary authorities are leading
the move to shore up the yuan, while others blame it for a recent bond rout in
the United States.
"Maybe China is behind the rise in US long rates,"
said Apollo Global Management economist Torsten Slok in a blog posted in early
October, when yields on long-term US bonds reached a 16-year high.
China's Treasury holdings started falling steadily after
peaking in 2013.
The balance of US Treasurys held by China totaled US$805.4 billion
in August, down 40% from a decade earlier, according to data from the US
Treasury Department.
China once actively bought the securities with its ample
foreign exchange reserves, becoming the second-biggest foreign investor in US
Treasuries after Japan. Given the size of its holdings, China's selling could
roil US bond prices, pushing up interest rates.
Not everyone, however, agrees with Slok's views, contending
that China could just as easily move its holdings to overseas custodians
without selling them. Yet many analysts focus on the decline in the country's
Treasury balance as a sign of Beijing's strong determination to defend its own
currency.
China is facing serious capital flight caused by rising
concern about its economic growth and debt burden. In September, capital
outflows reached US$75 billion, the biggest such monthly amount since 2016,
according to an estimate by Goldman Sachs. This exerts strong downward pressure
on the yuan, which now trades at around 7.3 against the dollar, the lowest
since 2007.
"China's state-run banks likely dumped the dollar
around October 01, National Day," said a currency trader at a foreign
bank, echoing the views of his peers. It appears that Chinese authorities urged
state-run banks to shore up the yuan against dollars and they responded by
selling Treasuries to raise needed funds.
Beijing has spent hundreds of billions of dollars out of its
foreign exchange reserves on market interventions since 2015, when its
devaluation of the yuan led to declines both in stock and currency prices.
Eager to maintain the current level of foreign reserve
balances, Beijing may have pushed state-owned lenders to support the yuan on
its behalf, according to analysts.
The yuan's daily reference rates announced by the People's
Bank of China show the sense of crisis being felt by authorities. While the gap
between the reference rate and the market value has widened to a record level,
the official midpoint remains pegged at 7.17 to the dollar since mid-September.
As China allows the yuan to fluctuate only within 2% on either side of the
midpoint, it looks as if the country has reverted to a fixed-rate system.
Taking advantage of the country's lower interest rates
spurred by monetary easing, some speculators engage in carry trade by borrowing
in yuan and converting the money into currencies with higher interest rates.
Goldman Sachs has proposed clients use borrowed yuan to fund bets on
higher-yielding currencies like the Brazilian real and other South American
money.
As speculators seek profits by selling the yuan to buy other
currencies, an increase in carry trade could further weaken the Chinese
currency. Many analysts expect that if such speculative trading increases,
Chinese authorities will have no choice but to step in to bolster the yuan --
possibly by unloading Treasuries.
However, the country's foreign currency reserves -- the
source of Treasury purchases -- are unlikely to increase as in the past as
export growth slows and the amount of foreign investment declines. Efforts by
Western countries to de-risk economic ties with China have only begun to take
effect.
If China continues to trim its Treasury holdings, market
players may see it as a factor pushing up bond yields and thus as a matter of
concern for the US Federal Reserve. The unsteady Chinese economy has added yet
another unpredictable variable to global financial markets.
