Chi­nese whis­pers are just what the US needs

The Sunday Telegraph - Money & Business - - Business - LIAM HALLIGAN Fol­low Liam on Twit­ter @liamhal­li­gan

Fi­nan­cial as­set prices were un­nerved last week by a mere whiff of geopol­i­tics. A news re­port sur­faced from Bei­jing, later de­nied, that the Chi­nese author­i­ties are think­ing of buy­ing fewer US gov­ern­ment bonds – known as Trea­suries. That made global mar­kets jit­tery, fu­elling con­cerns that one of the most sig­nif­i­cant trends of the last 40 years, the long-term fall in bond yields, is fi­nally com­ing to an end. Such a re­ver­sal would be a very big deal, pos­si­bly spark­ing a deeply dam­ag­ing 2008-style mar­ket spasm.

Even if the ad­just­ment from ul­tra-low rates is smooth, ris­ing bond yields still mean higher debt re­pay­ments for firms, house­holds and gov­ern­ments, which could stymie growth. And when bond yields rise, of course, their price falls, im­pos­ing big cap­i­tal losses on bond­hold­ers, not least pen­sion funds and other in­sti­tu­tional savers.

We know China owns around $1,200bn (£880bn) worth of Trea­suries, mak­ing it by far the world’s largest cred­i­tor to Wash­ing­ton. On top of those, swathes of US gov­ern­ment debt is also held via murky funds domi­ciled in Bel­gium – many of which re­port­edly lead back to Bei­jing.

China needn’t ac­tu­ally sell its Trea­sury hold­ings to send mar­kets into a tail­spin. Do­ing so would any­way cause the price of such debt to tum­ble, which would cost Bei­jing se­ri­ous money. But be­cause the Peo­ple’s Repub­lic soaks up vast amounts of new Trea­suries each year, just slow­ing its pur­chases could sig­nal trou­ble for the US bud­get.

Signs that could hap­pen caused the price of Trea­suries to fall last week, with yields jump­ing up. That spooked eq­uity in­vestors too, with ma­jor Western stock mar­ket in­dices post­ing end-of-day losses for the first time this year, break­ing the strong­est open­ing rally of any new year since 1987.

The­o­ries abound as to why this story emerged. Maybe Bei­jing wants to warn pres­i­dent Trump not to im­pose his threat­ened tar­iffs on Chi­nese ex­ports, show­ing “the Don­ald” who is boss? Or per­haps, un­der­stand­ably, with US in­fla­tion at around 1.7pc and ris­ing, the Chi­nese cen­tral bank sim­ply feels less of its mas­sive $3,100bn stock of re­serves should be in dol­lar­de­nom­i­nated sov­er­eign debt?

Cer­tainly, Trump’s tax cuts may be a “credit neg­a­tive” for the US, with Moody’s rat­ing agency last week re­port­ing they would “not be self­fi­nanc­ing”. Forth­com­ing tax changes, then, which have helped drive mar­kets up, could add to Amer­ica’s na­tional debt – which has dou­bled since 2009 and now tops $20,000bn.

That could be another rea­son China views Trea­suries as less at­trac­tive.

There are many other rea­sons, though, go­ing way be­hind China’s com­plex re­la­tion­ship with the US, why 2018 is likely to be the year of ris­ing in­ter­est rates across the West. One is that the US it­self has al­ready raised rates five times un­der out­go­ing Fed­eral Re­serve boss Janet Yellen, with three of those in­creases com­ing in 2017, the most re­cent last month.

The US cen­tral bank is also start­ing to re­verse its mas­sive pro­gramme of quan­ti­ta­tive eas­ing. Since 2008, the Fed bal­ance sheet has bal­looned from un­der $1,000bn to way over $4,000bn.

Hav­ing sig­nalled it will raise rates three more times this year, the Fed has also in­di­cated it will off­load as­sets bought un­der QE at a rate reach­ing $600bn on an an­nu­alised ba­sis by the end of 2018.

The Bank of Ja­pan and the Euro­pean Cen­tral Bank, mean­while, con­tinue to pump out QE money like billy-o, their bal­ance sheets still rapidly ex­pand­ing. But even th­ese last two QE hold­outs are slow­ing down – with the ECB about to ta­per its monthly bond pur­chases from €60bn to €30bn. The stated ac­tions of the Fed, then, mean more bonds will be hit­ting the mar­ket, while the BOJ and ECB will both be buy­ing less. All th­ese fac­tors put heavy down­ward pres­sure on bond prices, push­ing yields up.

Another big rea­son in­ter­est rates are now set to rise is that the global econ­omy showed signs of a fairly strong, broadly syn­chro­nised up­swing dur­ing 2017 – which looks likely to con­tinue. That could gen­er­ate in­fla­tion in coun­tries where price pres­sures, for some years now, have been sub­dued. Ad­di­tional in­fla­tion is also likely to stem from oil, with Brent crude now close to $70 a bar­rel, some 25pc higher than this time last year.

The Bank of Eng­land’s Mone­tary Pol­icy Com­mit­tee, hav­ing raised rates from 0.25pc to 0.5pc last Novem­ber, is likely to in­crease at least once more this year in my view, pos­si­bly twice. Pre­lim­i­nary data last week sug­gested the Bri­tish econ­omy per­formed well dur­ing the fourth quar­ter, with GDP grow­ing 0.6pc de­spite the first rate rise since mid-2007. That puts pres­sure on the Bank to go fur­ther.

The ECB, sim­i­larly, could be forced to slow down QE more quickly – which will push up eu­ro­zone yields even if the cen­tral bank’s rates re­main sub-zero at mi­nus 0.4pc for some time to come. With the eu­ro­zone set to ex­pand by around 2pc this year, the case for on­go­ing emer­gency mea­sures looks in­creas­ingly thin.

In­debted firms and house­holds ev­ery­where will be wor­ried about rate rises, of course. Across the world, in fact, the global debt-to-gdp ra­tio stands at 332pc – some 56 per­cent­age points higher than it was ahead of the 2008 fi­nan­cial cri­sis. Yet stock and bond mar­kets ev­ery­where are in bub­ble ter­ri­tory – their fragility shown by the wor­ry­ingly large im­pact of lit­tle more than a ru­mour of a mi­nor port­fo­lio shift in Bei­jing. On­go­ing “ex­tra­or­di­nary mea­sures” mone­tary pol­icy is pump­ing up mar­kets even more, rais­ing even great dan­gers.

Ul­tra-low rates, by warp­ing mar­kets and pro­mot­ing mal-in­vest­ment, have long been do­ing more harm than good. Fol­low­ing the Fed’s lead, it’s time for the world’s ma­jor cen­tral banks to raise rates, fi­nally emerg­ing from the shadow of 2008.

‘With the eu­ro­zone set to ex­pand by around 2pc, the case for on­go­ing emer­gency mea­sures looks in­creas­ingly thin’

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