The amount in Treasurys that China owns right now is a fraction of the $22 trillion in outstanding U.S. debt. However, that fraction represents nearly 18% of the securities held by foreign governments making China the world’s biggest consumer of U.S. debt.
But in the escalating tit-for-tat trade war between our two countries, if China decides to stop buying and start dumping its $1.13 trillion in Treasurys, bond yields could be driven “sharply” higher, warns Torchwood Capital Senior Advisor Giles Keating.
Keating told CNBC this week that Chinese excess savings had been flooding into capital markets and driving yields down, but “if that is now reversed, because China stops buying all those Treasurys, then bond yields can, I’m afraid, move up really sharply.”
A move like that could trigger a massive rise in interest rates on U.S. government debt, which would do plenty of damage to the U.S economy. But other analysts say such a move is unlikely given that it would also inflict pain in China.
BlackRock’s head of Asian Credit, Neeraj Seth, noted that while China may no longer be aggressively buying more U.S. notes, it also isn’t actively selling them.
“First of all, if you look through the last 12 months, and we’ve gone through enough of the trade tensions, China still holds about $1.13 trillion of U.S. Treasurys,” Seth said. That amount may be down about $46 billion over the last twelve months, but Seth says that represents a 4% decline and “is nothing significant.”
Seth also dismissed the possibility that China could swap Treasurys with other government notes, concluding that there aren’t enough “high-quality risk-free assets” out there to switch to.
Deutsche Bank macro strategist Alan Ruskin agrees, writing in a note from Monday that China making such a move would be too disruptive for its own economy.
“The ‘dissolution of Chimerica’ includes a retreat from China’s central role in supply chains, but also China’s supply of cheap U.S./global financing,” Ruskin wrote.
The Deutsche Bank strategist pointed out that China’s access to cheap financing has been drying up since 2014 anyway after its reserves topped out that year, and said that the “difficulties in finding liquid market alternatives is central to China’s reserve allocation dilemma.”
According to Ruskin, a “dumping” of Treasurys would end up being “disruptive for all markets inclusive of China’s own reserve assets and even more important its own asset markets.” Ruskin believes its far more likely that China’s approach will be a “slow structural bleed” in its U.S. bond holdings.
For now, markets don’t seem to be too worried that China could start dumping its Treasurys, especially since such a move wouldn’t come with much upside.
“It’s a self-destructive nuclear option,” Robert Tipp, chief investment strategist and head of global bonds for PGIM Fixed Income, said. “Maybe it helps them as a bargaining chip, but it’s endangering the value of something they’re deeply involved in.”