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China's CNY Move Is Bearish For Treasuries
We pointed out previously that the one certain mid- to long-term impact of China's revaluation decision, aside from stimulating the US manufacturing export economy (don't laugh), will be to trim Chinese interest for bonds. This is due to a direct effect of fewer Chinese dollars being recycled into USTs now that less USD reserves will be accumulated, but also due to an indirect effect of stimulating demand for risky assets, pushing USTs off the plate of investors. For a much more in depth perspective, we provide the views of MS Rates strategists Jim Caron and Igor Cashyn.
China’s RMB Revaluation – Bearish for US Treasuries over the Long Term
Jim Caron, Igor Cashyn
From a US rates perspective, China's decision to exit from the renminbi (RMB) peg to the USD and allow its currency to strengthen is, at the margin, bearish for UST bonds over the long term. It simply means that China will accumulate USD reserves at a slower pace, although we note that the pass-through between FX and reserve growth is not always linear. With marginally less dollars to recycle into USTs, we anticipate that the size of the direct impact of allowing the RMB to strengthen – say a 5% revaluation – will likely be slight – on the order of ~$12 billion less coupon USTs purchased per year. Still, the importance of this is clear, as China is the largest creditor to the US Treasury, and this lower purchasing flow will have to be priced in at some point.
The much more immediate bearish impact on Treasuries may stem from the positive indirect impact this revaluation has on risky assets, as the revaluation should be supportive for US growth dynamics and many emerging markets. Our China economist, Qing Wang, broadly goes into the positive risk sentiment borne out of China’s decision to revalue its currency. They are as follows:
i. Reduction in risk premiums stemming from fear of a Sino-US trade war;
ii. It reduces the probability of an aggressive policy tightening or heavy-handed credit controls; and
iii. It increases the probability for further revaluation over time.
We believe that the revaluation should minimize any disruptive influence on the AXJ region and the global economy. We still see emerging markets as the engine of world growth, at 7.3%, with China growth alone running at 11% in 2010. The revaluation effectively provides a tailwind for global imbalances to start a process of rebalancing in which the US will be a prime beneficiary. It is for these reasons that we believe that the revaluation is bearish for USTs but underscores that these bearish forces would take a long time to play out. Further, the size of the revaluation is not yet known, and as of June 20, this foreign exchange rate is unchanged at 6.8275.
China’s allocation of foreign reserves. To understand what direct impact China’s decision to revalue its currency will have on the US rates market (i.e., how much less US assets China will buy), we first have to examine which assets are likely to be most impacted. That is, where does China invest its dollar reserves? In Exhibit 1, we illustrate China’s holdings of various US securities from the Treasury’s annual survey of US securities held by foreign entities, with the latest report published for June 30, 2009. We then use the Treasury’s monthly TIC flows to bring this data up to speed through April 2010, although we caution our readers that the monthly TIC flows are likely to understate the true growth in Chinese purchases as flows conducted via money-center banks in other countries (e.g., the UK), may not be attributed to China
right away. Instead, they are corrected only in the annual survey. Thus, the $101 billion inflow into Treasuries between June 2009 and April 2010 is likely underestimated.
We find that pre-crisis, China – like so many other sovereign at the time – favored US spread products over risk-free Treasuries. However, this all started to change for the year ending in June 2009 – the latest available annual survey, when China ramped up its purchases of coupon Treasuries and became an outright seller of both Agency debt/MBS and Corporates (see Exhibit 1). And while China has slowed its selling pace of Agency debt/MBS as of April 2010, it has yet to fully return into this space. Thus, of the market’s in which China has been historically active, it is the US Treasury market that will be most impacted by any shift in China’s dollar reserve growth.
Sizing the direct impact. Exhibit 2 presents historical changes in the RMB/USD exchange rate, the growth in China’s total foreign exchange reserves (i.e., not just US$ reserves), and China’s purchases of coupon Treasury debt. We note that China’s total foreign reserves actually increased the most for the year ending June 2008, or at the precise time one would have expected China to decrease given the 10% strengthening of its currency. One rationalization is that a stronger currency was needed to offset an even larger growth in China’s foreign reserves, but more importantly, this goes to show that the pass-through effect on China’s reserve growth is far from linear. Therefore, it may be hard to trade the impact of the latest revaluation move via a view on Treasury yields.
However, if we were to assume that, for example, a 5% RMB appreciation over a 1-year period led to a 5% drop in its foreign reserves growth and a corresponding drop of 5% in its coupon Treasury purchases, this would lead to only a $12 billion drop (assuming that the Jun09 annual inflow of $235 billion stays constant). Compared to annual net issuance pace of coupon Treasuries at $1.367 trillion and $1.110 trillion in F2010 and F2011 (see Exhibit 3), a $12 billion drop in purchases will have a marginal impact at best. But again, as we stated above, we do not expect a revaluation of the RMB to have a linear correspondence to UST purchases or yields.
Impact on the UST yield curve. This will also be difficult to discern. On one hand, Treasury auction data indicate that aggregate foreign investor purchases – a good proxy for China’s own flows – have targeted the 3y UST sector with the 5y sector next in line. So, one could argue that a revaluation in the RMB and subsequent slowing of UST purchases might impact this sector most and the yield curve might have a bias to flatten from the 3y-5y sector on out. But on the other hand, to the extent that a currency revaluation is supportive of US growth dynamics and other risky assets, then one could argue that the more immediate impact would be a steepening of the UST yield curve. The important thing to remember is that China’s currency policy is only one of many factors that might influence the shape of the yield curve.
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Good article, but leaves me somehow pissed off... another example of why we're so screwed in the long run. Chalk this up to another blight our children and grandchildren will have to deal with, because we don't act in this country, we react.
Unless there's a disturbing upheaval in the markets or unless the impact of people losing their homes/jobs/healthcare/savings/etc... reaches a tipping point, nuthin's going to happen in this country in the near term. And all of the armageddon talk is just shallow hyperbole and adds nothing to the conversation.
Something real needs to set this off, or the Treasury and Fed will just keep making the drunk monkey dance while we watch in horror. I'm guessing that maybe the Tea Partiers sweep in and enact a whole lot of economically depressive policies. Or maybe the HFT programs have THE flash crash, the big one.
Because as the market keeps going up, lots of people out there start confusing their hope with prescient bullishness (that old "don't confuse brains with a bull market" thing). If this thing keeps going up, it will keep going up, and eventually tank. And then the Fed and Treasury will crank it up again. Until it tanks again. And they crank it up again.
A country as big as the US could make the drunk monkey dance for how long? Decades?
Sorry... I'm cynical today.
Yes, the "drunk" money could easily go on for "decades". Remember, you got a shitload of economists out there saying that there is no problem with running a gigantic deficit or continuing to print money. Until all of those guys are convinced that it won't work, it'll continue. And, yes, that could be decades.
oh, also the slight problem that every US consumer item (aka all of Walmart) is made in China - guess what prices will start moving up? Politicians will regret what they wished for when riots start happening because no one can afford clothing or lawn chairs or whatever the fuck other shit gets made there (aka everything).
Thats the whole point. We want people to stop buying their crap.
People think for some reason that stopping Chinese manufactured goods from reaching American shores is going to bring back the industry we have driven to the four corners of the globe.
It's not going to happen. The most it will do is shift around our trade deficit. Once people realize that we are getting stuff for free using bad checks, and thus stop stockpiling them, we will finally be forced to either accept much lower purchasing power abroad, or we will be forced to get rid of all of our industry killing taxes and regulations.
and manufacturing it here for less and spending less overall. walmart won't pass on prices that it thinks won't work. they are very good at maximizing volume sales by getting the price point right.
trav7777's avatar is Walmarts new price rollback advertising icon...
http://www.zerohedge.com/sites/default/files/pictures/picture-10919.jpg
Walmart will know to the exact penny what the net effect will be, they will be fully hedged and the result will be robust profitability for them.
and iPads.
I remember the last lawn chair riots, they were quite something :)
Bullish for risk assets, and wait till they pass an alternative energy program!
I'm skeptical about that, Leo. If it's bullish, it's only marginally so. If the allocation to Treasuries is reduced, it will most likely need to find another low-risk store of value type of replacement. That's not alt energy or other risk assets.
If an appetite is lost for US treasuries, how would an alternative energy program be funded? It is more plausible that any cash the US has left will be to bail out California - escalating the dollar's demise.
gemini,
How will it be funded?.
Tax increases, and stealing your 401k, and IRA's...........raising your fuel & electricty costs to 3x's what they are now.........
Forcing you to walk on a motgage, or if you own, force you to sell(give your home away), because you cannot afford the taxes, and high energy bills...............imagine what this will do to fixed income folks............
The Tea Party, may just BE the one's that stop this SUICIDE pact.......they are very proactive,winning SUPPOSEDLY unwinnable races, and now they are forcing recall elections of sitting reps............
These folks are pissed,and Homey ain't playing.
Get enough folks OUT in Nov, defund the shit out of these Marxist programs, and we could well see....the train stopped.
Tea Baggers are gonna save us? Wow. The majority of Tea Baggers are either retired or close to it. The retired ones are worried the free ride is gonna end and the ones who want to retire are worried the freebees will be gone before they retire.
You want to know how clueless the average Tea Bagger is? They actually think they deserve every penny of the bennies SS and MC are going to pay them for the 20-30 years they will be sucking on the big government Teat. The amount they paid into SS and MC does not come close to paying for the benefits they will receive, Does not get anymore greedy than that.
I don't know who these Tea "Baggers" are that you refer to, but speaking for myself, I'd have a lot more currency in my pocket if I did NOT have to support all the dead weight that Govt taxes us for. Sorry fellow Baby Boomers, but the Govt. lied to you about Social Security, and pretty much everything else!
It might be bullish... unless a Treasury auction goes really bad.
I'm not saying that it will happen anytime soon, but the Fed and its partners are going to run out of effective capacity in the not too distant future.
Of course the last straw will be after the Fed's $5T monetization program, coming to a theatre near you, in stunning 3D.
Just what do you give a Govt that's taken everything?
It'll be like a party where NO ONE shows up!
Nonsense. China has already been buying less treasuries because we are all borrowing less to cycle through them.
China wants/needs to buy the EURO now. China does NOT want to suffer the deflationary trends in money supply that WE are experiencing.
This has nothing to do with wanting to get off the dollar, they are desperate to find another peg that lets them continue mercantilism and a forced equation to the dollar is not working right now. It's causing contraction in their economy. This is why they did a stimulus, because global borrowing has stopped.
If the dollar is semi-hard because of the oil "peg," then the deflation imposed by this would hit any nation pegged to the USD. China will devalue now versus the euro in hopes that they can gut the EU's industrial base.
China wants to act more responsibly. They recently backed off their hard line against Iran sanctions. They may even try to help resolve the Korean problem, and they are now willing to play kick the can down the road with Bubble Bernanke. The China hype will have to be examined at some point, just like the Russia hype, ever since the wall in Berlin fell, the neo Capitalist movement has been ready to take over Mother Russia, and how about SE Asia Tigers, Vietnam? The financial hype machine was going there for a decade. There is also the SA hype machine, Brazil isn't doing too badly, but they have problems. The Chinese aren't operating from a position of strength, which means all of Asia is in trouble. Where is the next source of cheap labor? Mars probably, better hurry up Mr President, because once the whole world is on the same labor and wage standard there is no more free lunch.
What agreement did you read? Stop watching Faux News or listening to that blithering idiot Billary.
The Chinese are playing the Iranians for more favorable terms on their energy and development deals. The new sanctions don't touch a penny of Chinese investment in Iran or limit all the new production and refining facilities they are building there.
Russians don't need oil or gas so they have also been playing the Iranians for fools. Every talk of sanctions pumps up the value of Russia's oil and gas. A $20 swing in the price of oil means the Russians will make more in a few months than any pathetic sales of military equipment to Iran. The Russians have been trying to force the Iranians to agree to Russia's plans for controlling the pipelines and pricing contracts throughout Asia and Eastern Europe. Since the Iranians have their own plans and the protection of the Chinese, the two have been fighting each other for years. In the end the Iranians will win the battle of control and route their pipelines where they want. The Russians are stupid to keep playing these games. In the case of the Iranian reactor, the Russians, US and the limited number of countries supplying reactor fuel, want to keep their monopoly. The Russians want to sell reactor fuel to the Iranians at inflated prices. The Iranians know they must have nuclear power to meet their energy needs for the next 50 years. The Russians have been F'ing the Iranians for years on finishing the reactor. In the end the Chinese will probably be the next supplier of reactor to the Iranians.
We just need 2% up in the short term of the curb for a implosion. I do not think China its going to dump US treasuries. So Timmy is safe, lucky b^%$...
Same Old Shit.
Gun the market higher on any reason(excuse) that can be distorted into a rationale for buying.
Problems affecting US economy and US equity market:
1) $130T in unfunded government liabilities
2) Massive deflation of common assets such as home prices
3) Almost every major financial institution insolvent. Only kept alive by FASB changes.
1267) $ overvalued vs yaun
Also, equities overvalued: using Schiller's rolling 10yr avg. stocks at 20.4 p/e versus long term average of 16. Even if someone out there wants to argue that stocks merit a higher p/e these days, it's tough to argue that long term bull markets begin at or above the mean. Long term structural bull markets begin when stocks are CHEAP. As in, way below the mean. As in 6 - 8 p/e (apples to apples)
Who gives a fuck about treasuries? We all need to pile into REITs.
God knows, this sector just can't NOT find a way to increase 2% every single day. Clearly, devaluing the yuan directly impacts commerical real estate.
IYR continues it's completely absurd trajectory into outer space.
An SDR commercial? China uses the SDR basket, declares it a success for the rest of the world to see.
They left out the disclaimer of "ceritus paribus". I disagree with this analysis. Any uptick in interest rates will kill any "nascent" economic recovery and that will kill risk assets and that will cause the buying of treasuries. We have a deflationary negative feedback loop.
Um, it's "ceteris paribus," but I think you're probably right about deflation and UST's.
Peter Cetera fan? I did it for the lulz, yo. At least your techno-savvy luddite self was able to translate my pig latin. :>
Didn't mean for that to sound so snarky, Cursive. I had years of latin in school, and I guess I'm still pissed about it.
We've kicked the can of economic contraction down the road so many times the can has turned into a giant boulder, and it's slowing down fast. Once this thing stops, it's not going anywhere. The children of America are so fat, lazy and uneducated in history that they'll welcome with open arms a despotic regime that scraps the constitution as long as they still get the latest iPhone or XBOX games. The spirit of lawlessness is already well at work in the hearts and souls of the next generation.
Buy gold? How about buy lead.
"First, China has not added anything to its hoard of U.S. Treasury securities since June 2009. In fact, it has run down its holdings by a modest amount. Guess what? The yield on the U.S. 10-year note has dropped 40 basis points, to 3.3% over that period. Go figure."
From Dave Rosenburg this morning. Hmmmm....I know there will be an initial knee jerk reaction, but lets be realistic and long term here. Inflation? Non-Existent. Deflation? A mere certainty.
There are no certainties in life. I have yet to see a rational explanation for deflation with the dollar backed by debt, and with the U.S. Treasury issuing greater than $1T additional debt per year.
What happened to death and taxes. Obama and the Grim Reaper are gonna be really pissed about this development. (Sorry, couldn't resist)
There are two certainties. If there are tits or wheels involved, you can sure you will have problems from time to time.
Looking at the daily DOW chart, looks like a long bleed has started since 10:30 for the rest of the day. 10,350 on taps by close??
Wow, you all really think they will let the RMB rise? OK, I will take the otherside of that bet. After the G-20 meeting watch for the RMB to FALL to 7:1 area unless the Euro strengthens significantly. Now the Chinese can say it is the free market driving the exchange rate. They cannot afford their economy to cool too fast or they will be out of power and all of their bubbles will pop. They even said, a strong RMB is not in China's best interest. I am far from a rocket scientist, but I am not a moron either and when everyone is pointing towards things heading in one direction I expect the opposite to happen.
+1. I think you are absolutely right. They are not going to let all those shops with 2% profit margins close up and send all those millions of low-paid laborers home back to the interior to starve.
i say this is a smoke screen they have enough $ and euro to keep yuan where they want it. not a monetary guy my 2 cents
I would argue that any additional value of the Yuan vs. the Dollar will have a downward pressure on short term yields.(even though today looks a little better) Allowing the Yuan to float is only a temporary measure, the inevitable outcome will likely be a negative international libor for short term funds in Yuan or perhaps negative yields on repos.
Take your pick.
Looking at three-month yields here is surprising to say the least, because the discount rate is higher right now, but tends to follow behind 3-mo. treasury yields. They have a long way to go in the Eurozone by lowering policy rates to match their short term yields and are greatly disadvantaging themselves by holding their policy rate far above short term rates.
http://finance.yahoo.com/bonds
China has trillions of Iraqi Dinars stashed in their treasury. They also have, if I'm not mistaken, over 70% of all new oil well drilling contracts over there. China will revalue its currency, as they will rely on Iraq's wealth to keep them going...just like USA.
Iraq will only supply a small portion of China's needs. Russia and Iran will supply far more oil and gas to China. Look at all the new pipelines being built in Russia and Iran headed to China. You actually think the Chinese would pour huge dollar amounts into any country controlled by the US?
"You actually think the Chinese would pour huge dollar amounts into any country controlled by the US?"
More than that, China forgave Iraq 80% of its debt. Soon thereafter the oil contracts were announced. All five permanent members of the UN Security Council have mass stashes of Dinars in their central banks plus juicy oil/construction contracts. From what I read, Iraq has the most profitable oil wells because it only costs $5 to extract a barrel.
The Iraqi Dinar will have a shot at becoming the world's most powerful currency. Soon...real soon.
China forgave the debt because it was never going to be repaid anyway. Forgiving the debt was the entry cost to bid. Dinars are still worthless outside Iraq and will be unless the US holds a gun to the Iraqi leadership forcing them to trade oil for worthless Dinars.
The chances that Iraq can start pumping oil at a much higher rate anytime soon is pretty slim. China is looking long term after the US leaves and the resulting civil war is over. I would guess more than 10 years will go by. The Iraqis will be forced to renegotiate the terms with all winning bidders since the profit per barrel they are allowing foreign investors to make is too low and the risks are very high.
Just about everybody who's a big player has forgiven a big chunk of Iraq's debt.
Iraq's oil production will not increase immediately, that's true, but they DO need a tradeable currency. To move things in such direction, the IMF has loaned money to stabilize the currency plus tons of gold and cash that were confiscated to Saddam Hussein have been returned to the Central Bank of Iraq. Things are happening according to plan. Slowly, but happening.
Soon I will buy a farm and Libertad...with worthless Dinars. This is an investment for the poor & faithful.