TIC tock; TIC tock; TIC tock
No, the US Treasury’s time is not running out. Where’s Brad Setser when you need him – and the media definitely needed him in reference to the December TIC report.
Okay, okay, we know: China dropped its share of Treasury holdings in December by $US 34.2 bn. China now holds just 20.9% of the total foreign-owned stock of Treasuries, second only to Japan (21.3%).
But China’s share is closer to its average, while Japan’s share is way off – there may be a reversion here, i.e., Japan will grow its stock of Treasuries relative to China (Please see my post yesterday). Except for the period of September 2008 through November 2009, Japan held a much larger share of Treasuries than did China for every month since 2000.
Is there a sinister plot developing? Is China selling off S-T T bills to retaliate against the Obama administration’s push on the renminbi? Or is China simply reallocating its portfolio toward risk?
Perhaps there is a (partial) retaliation scheme underway, as suggested by the 3-month accumulation of short-term US assets (mostly T bills agencies with a maturity of less than 1 year).
But isn’t it just slightly more plausible that the Chinese are – official + private – selling off zero-yielding (practically) Treasuries in exchange for longer-duration, higher-yielding, and riskier assets.
The first bit of the story is this: one should take care in not reading too much into the TIC report. It’s just one month’s worth of data; but more importantly, the data miss a critical component of the capital account, foreign direct investment.
The chart above illustrates China’s one-year rolling monthly flows of long-term, high quality asset purchases – Treasuries bonds/notes, agencies, stocks, and corporate bonds. The Chinese are accumulating stocks, primarily through private investors, but through official channels as well (see press release, lines 8 and 13). This suggests an increasing interest in equity, which could signal growing foreign direct investment flows (not shown in TIC).
Furthermore, the entire year’s shift in assets, long-term Treasury purchases, +$US 98.8 bn fully offsets the drop in short-term Treasuries, -$US 98.8. This suggests diversification.
Finally, everybody’s doing it, not just China – diversifying away from T bills, that is!
The chart above illustrates the 3-month rolling sum of all foreign net flows of ST US assets (mostly T bills). If you invest $US 1 million dollars today in a bill expiring in August 2010, you make about 900 bucks. Man, doesn’t that sound like a wonderful investment?
So the next question is: why do the Chinese care about return on their F/X holdings? Because they have a peg! Here is a great article for all of you who wanted to know about the costs of maintaining a peg. Accumulating FX reserves is a costly business, and T bills are unlikely to finance the type of sterilization that is needed by the PBoC.
Some of the bond traders at Zero Hedge and Seeking Alpha sure think the bond market will come unglued over the next six months with all sorts of reading into numbers.
The recent 30 year auction was not good so not sure if they are trading up to higher yields:
“Or is China simply reallocating its portfolio toward risk?”
Or is China simply reallocating its portfolio away from risk?
Looks like they are fleeing towards risk – whether its Treasury bonds (rather than bills) or FDI Where? Zimbabwe? They’re already there. Venezuela? Already there. Stocks? Already there. I’d say that these are riskier endeavors with return potential in mind.
My recollection is that China has recently publicly instructed all domestic institutions which hold official reserves to purchase soveriegn and government backed debt, as opposed to other instruments. I’m not aware that a maturity preference was expressed in that announcement, but certainly the government will have preferences as regards maturity.
There is not just one type of risk, and China is necessarily fairly sophisticated in its handling of reserves, because it has so many and, as noted above, reserves are costly to hold. Given the instruction I’m pretty sure was issued to holders of Chinese reserves, it seems unlikely that China is seeking risk, period, no qualifications. China may be seeking the risk that is associated with longer maturities, but not the risk associated with non-sovereign entities. The steepness of the curve means that the relative gain in yield is as high as it has ever been for moving out the Treasury curve.
Note also that the US Treasury has an effort underway to extend the maturity profile of outstanding debt. If China is shifting the maturity of its Treasury purchases outward, then China is facilitating implementation of a stated Treasury goal.
I would be wary of that link to “Market Ticker” given the hyperbole used in describing the 30-year auction. The 2.36-to-1 cover was far from the recent low. A year ago at the bond auction, the cover was 2.02. If a cover of 2 is a failed auction – a claim that is not backed up in any way by the author – that still leaves open the question – how far from 2 is 2.36? Well, the last time the c over was above 3 was in 2000. In addition, in the 2000-2008 period, there were 6 30-year auctions with covers ratios below 2.
Similarly, the “Market Ticker” piece highlights the “% tender at the high” figure as a sign of trouble, when there have been several recent 30-year auctions with higher shares taken at the high than at the most recent auction. If the February bond auction was a solid “F”, then Treasury has been getting Fs in periods of high deficit as well as surpluses, periods of steep curves as well as flat ones. I have to conclude the guy who wrote the “Market Ticker” piece doesn’t really have a very strong grasp of Treasury market fundamentals. Looks like somebody started with a bias and then simply claimed the data support the bias.
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