How the yuan’s return to stability helped China become the largest holder of Treasurys


China holdings of U.S. government paper rise to $1.147 trillion, up more than $44 billion from the previous month.

China’s efforts to stabilize its currency are finally looking to pay off.

The yuan’s USDCNY, +0.0090%   strengthening against the dollar in the past three months has helped nudge China, the world’s second-largest economy, to reclaim its spot as top holder of Treasurys in June after an eight-month hiatus, relegating Japan to second place. The dollar bought 6.68 yuan on Wednesday trade after having hovered at levels of 6.90 yuan back in May.

China’s holdings of U.S. government paper rose to $1.147 trillion in June, up more than $44 billion from the previous month. Meanwhile, Japan’s holdings slipped $20.5 billion to $1.09 trillion, according to data from the Treasury International Capitol system on Tuesday.

The strengthening currency, along with its status as a major exporter, has helped boost China’s current account, which largely matches the size of its trade surplus. This can lead to a rapid accumulation of Treasurys, as a burgeoning trade surplus has to be balanced with Beijing raising its cross-border investments into other countries.

Credit: Capital Economic, Thomson Reuters
China is re-building its hoard of Treasurys

The report comes on the heels of the Communist Party’s efforts to stabilize the currency ahead of its once-every-five-years leadership shuffle that could prove pivotal to how Chinese economic policy evolves. Minimizing market turmoil could serve as “window-dressing” for the occasion, said Tim Alt, fund manager of rates & currencies at Aviva Investors. To do this, the central bank has fought against speculators from shorting the yuan.

“In light of the upcoming Party Congress and the ongoing U.S.-China trade negotiations, we would expect the authorities to push back against any significant idiosyncratic depreciation pressure on [the Chinese yuan] in the next couple of months,” said Goldman currency strategists in an Aug. 16 note.

After Moody’s downgraded its credit rating for sovereign paper, prompting a rush of bets against the yuan, China attempted to swat away the short-sellers by “fixing” the currency. On June 1, the country’s central bank set the dollar’s daily midpoint at 6.8090 yuan, the strongest level since Nov. 10. In effect, this pushed up the yuan’s value well above the previous session’s trading levels, catching flat-footed foreign exchange traders who had wagered against it to weaken.

Moreover, Beijing is cracking down on outbound mergers and acquisition this year. Chinese companies engaged in more than $200 billion worth of deals in 2016, an all-time record, data from Dealogic shows. Some economists have suggested the blockbuster deals are a way of circumventing strict regulations on capital flight.

In response, Chinese authorities detained one of the more prominent wheeler-dealers, Anbang Insurance’s President Wuxiao Hui. They have also named and shamed property behemoth Dalian Wanda and conglomerate HNA. As a result, deal volume from China to U.S. firms have slumped 65% year-on-year in 2017 so far.

“All signs point to a deceleration of the three-year run for China outbound M&A into the U.S.,” said analysts from Dealogic.

The stream of money escaping the country has dried up into a trickle, lifting the downward pressure on the yuan. Net foreign exchange flows out of China slipped to $14 billion in July, according to data from Goldman Sachs (see chart below). Since February, outflows have fallen below $25 billion for six consecutive months, a sharp contrast from 2016, when the monthly readings regularly topped $50 billion.

Credit: Goldman Sachs Global Investment Research
China’s authorities have successfully stemmed money flows out of the country.

All credit, however, shouldn’t rest with China’s technocrats, who have regularly interfered in their own financial markets. The dollar’s steady descent as Trump’s pro-growth agenda is put on the backburner has given a boost to all currencies against the buck, not just the yuan. The ICE dollar index DXY, +0.05% , which measures the greenback against six major currencies, has plummeted more than 8% year-to-date.

But what does this mean for investors? Purchases of Treasurys from China are closely watched by bond traders as analysts suspect large foreign buyers like China have kept a lid on yields for U.S. government paper, despite the Fed being on track to raise rates a few more times by the end of next year.

The bump in China’s total holdings coincided with anecdotal reports that it was playing a bigger role in trading activity for U.S. bonds as the summer began, said Thomas Simons, senior money market economist for Jefferies.

He suggested the relatively strong performance of Treasurys sporting extended maturities since June could be tied to the country’s return to normal trading activity. Analysts said Chinese bond-buyers, be it central bank or professional investors, have a preference for longer-dated sovereign debt.

By Sunny Oh
Market Watch


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