Now that China is buying Treasuries again, maybe it’s time for everyone else to sell.
Having liquidated a record amount of U.S. government bonds in 2016 to stabilize the yuan and rein in capital flight, China’s central bank is buying again and seen willing to accumulate more. Riding the coattails of a $3 trillion giant may be a tempting strategy, but China, and reserve managers as a whole, have historically added Treasuries during periods of rising yields.
Besides buying when prices are falling, why is China an anti-cyclical buyer of Treasuries? And why is it a bad idea to pile into bonds simply because China is buying?
That’s because currency reserves, where the bonds are held, tend to rise during periods of healthy global growth and during risk-on market environments. China’s central bank amasses dollars when the nation runs a current account surplus by selling more goods than it buys internationally. Dollars also pile up when authorities sell the local currency against the greenback to prevent it from appreciating too fast, like China did to slow the rise of the yuan for the better part of the last decade, resulting in its burgeoning coffers.
While Chinese buying isn’t necessarily a screaming sell signal, its implication on the global economic landscape can’t be mistaken, according to Bank of America Corp. rates strategist Shyam Rajan.
"Reserve managers are the only guys who’re likely to buy into higher yields," said Rajan. "Usually higher global growth implies reserves inflows, which imply reserves managers’ buying of Treasuries."
Indeed, China’s economy is stabilizing. The manufacturing sector is growing again, factory prices are reflating, consumers are still spending, and capital flight has shown signs of abating. All that has helped to stabilize the yuan and enabled the People’s Bank of China to accumulate reserves. After bottoming in January, the nation’s reserves rose $55 billion to $3.05 trillion in May, contributing to a $29.2 billion increase in China’s Treasury holdings this year.
The 10-year Treasury yield has risen three basis points this week to 2.19 percent.
"China probably feels their exposure to Treasuries is on the low end, and they’re comfortable buying Treasuries," said Paresh Upadhyaya, director of currency strategy in Boston at Pioneer Investments, which oversees about $244 billion. "It reflects the belief that China is confident that the measures they took to prevent capital outflow has succeeded and they have stabilized the yuan."
That’s a stark contrast to China’s plight in 2015 and early 2016, when the central bank burned through billions in Treasury holdings to prop up the yuan amid signs of a flagging economy. The episode is also a case in point about the often inverse relationship between China’s Treasury investment and the overall trajectory of yields: Amid China’s record selling, bonds rallied on safe-haven demand and speculation that the Federal Reserve will be forced to delay raising interest rates in fear that a hike will derail the global economy.
In a nutshell, think twice before piling in.
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