Chinese whispers are just what the US needs
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’