China may curtail or stop its purchases of U.S. debt
‘Bloomberg News’ report spooks financial markets
Financial markets were jolted Wednesday by a report that China — the biggest foreign holder of U.S. government bonds — could curtail its purchases, a shift that has spooked investors already leery of a rise in interest rates at the start of 2018.
Bloomberg News, citing unnamed people close to the matter, said Chinese officials are considering slowing — or even stopping — its purchases of U.S. government debt. The report suggests that China feels U.S. debt is becoming less attractive when compared to other types of investments. Trade tensions between the world’s two largest economies was also cited as a possible reason why China is thinking about reducing its U.S. holdings, according to Bloomberg.
“If the reports turn out to be true and China no longer sees Treasuries as an attractive option, the repercussions could be significant,” says Craig Erlam, senior market strategist at OANDA, a currency trading firm with offices in New York. “A significant change in policy could put considerable upside pressure on U.S. yields.”
Low interest rates, of course, have been a big driver of the stock market rally the past nine years and have also provided a lift to the economy, as middleclass Americans have benefited from lower borrowing costs.
At the end of October, China held $1.19 trillion of U.S. Treasuries, the most of any foreign country, according to the latest data from the Treasury and Federal Reserve Board. Japan was second with U.S. bond holdings worth $1.09 trillion.
The fear is that, at a time when the Federal Reserve has started reducing its holdings of U.S. debt (coupled with news that Japan is reducing its Treasury purchases and China might follow suit), there will be less demand for U.S. debt. And that fewer buyers will result in higher interest rates and borrowing costs in the U.S.
Bond investors would also get hurt because falling bond prices is the cause of higher yields.
But Erlam says it is too “early to speculate” on the likelihood that China will “suddenly” reduce its holdings. What’s more, he adds, it is likely that China would tread carefully if it does opt to sell U.S. Treasuries so as not to “destabilize the markets.”
The financial market reaction to the Bloomberg report was swift. The price of the 10-year U.S. Treasury note fell, with the yield, which moves in the opposite direction, climbing as high as
2.598%, its highest level since March 14,
2017. It finished unchanged at 2.55%. Stocks also dipped, with the Dow Jones industrial average closing down
17 points.
Interest rates had already been rising to start 2018, as investors begin to price in prospects for faster U.S. growth, more interest rate hikes from the Federal Reserve and rising inflation pressures, in part due to rising wages as the job market tightens further.