The Mystery Of Chinese Treasury Holdings

Frequent readers are aware that in the past month, Zero Hedge has speculated on both the direction of Chinese UST holdings as well as the identity of the direct bidders. Our thesis, presented over a month ago, was that Chinese accounts, operating as UK-based direct-bidders, are perpetuating a form of covert easing, by buying treasuries which never hit the TIC account as a Chinese counterparty and thus remain under the radar, being relegated to UK purchases for all official purposes (whose holdings have spiked in 2009). To be sure, this theory was met with some skepticism within the Zero Hedge community. The just released TIC data, which highlighted the biggest monthly drop in Chinese holdings in years (and biggest UK holdings surge), provides yet another piece of the puzzle, has increasingly led experts to concede that something is off about Treasury holding patterns. (No such ambiguity exists when it comes to MBS: everyone is hitting the Fed's bid there).

Market News quote Stone & McCarthy analyst Nancy Houten:

"A number of press outlets are concluding that Japan surpassed China in December as the largest holder of Treasury securities," a conclusion they drew "based on a table of foreign holdings of Treasury securities published each month by Treasury as part of the broad Treasury International Capital (TIC) data," she said.

"And Treasury's table of foreign holders of Treasuries indeed showed Japan with $768.8 billion in December, up from $757.3 billion in November, and China with $755.4 billion, down from $789.6 billion," she added.

She stressed that "it's important to understand how Treasury comes up with those figures, however" as for "for foreign holdings of Treasury bills, the figures come from TIC reports on short-term liabilities to foreigners that are held by customers of U.S. banks and brokers/dealers of securities. The short-term liability data tend to be a fairly accurate measure of a foreign country's actual holdings of short-term U.S. securities at a given point in time."

But the SMRA analyst cautioned that "for both China and Japan, Treasury bills make up less than 10% of their total Treasury holdings; notes and bonds make up more than 90% of their total Treasury holdings. And Treasury's estimate of foreign holdings of notes and bonds is a much rougher gauge of actual holdings" as Treasury gets that estimate from adding monthly net purchases of Treasuries from the monthly TIC data to the level of each country's actual holdings identified by the Treasury's latest recent annual survey.

The problem arises, she added, since the "monthly transaction data are subject to certain biases" with the "most significant bias" that "the TIC data attribute transactions to the countries where the counterparties are located, and one of the counterparties must be in the U.S. As an example, purchases of Treasuries by China would reflect only purchases by an entity in China from an entity based in the U.S. The data wouldn't pick up purchases done on behalf of Chinese investors by dealers in the UK or Hong Kong, for example, nor would it pick up purchases of Treasuries by investors in China from investors based outside of the U.S."

 Some view the TICS data as open to interpretation. One trader noted that "hopefully," the Chinese selling in T-bills meant that "they are getting ready to re-load" soon by buying Treasury coupons in an "opportunistic" fashion. "Or else, they are putting the screws to us" in the United States by selling Treasuries, he added.

"They also say, the Chinese could be buying offshore" in locations where Treasury data would not pick up that buying as being from China, he added. "This (Chinese buying offshore) could be where the indirects bids are coming from."

One key observation that we have ignored, is that China may not be actively selling its securities, but merely letting Bills roll off without replenishing. The difference is minor but nuanced, as it represents a slightly smaller degree of "revulsion" with holding US debt.

A different trader agreed that the TICS data are open to interpretations but said, "I think the Chinese let the bill maturities roll off" without being immediately replaced. "They were not selling," he added. "It was more the bill maturities rolling off. I don't think too much has changed."

But he agreed that "that is always the big fear in the market, that they would be selling," however he felt that was not happening, but more China allowing maturing T-bills to roll off in December, with the view to replace such holdings later at a higher yield in the Treasury coupons. "They would replace them later on," said the trader. 

A notable quantification catalyst will be next Friday's release of the Treasury's survey of foreign holdings of U.S. securities which will stratify UST holdings much more accurately . The only problem is that it will provide a snapshot as of June 2009, thus not really providing much clarity into the recent transfer of holdings.

All this data has to be considered in light of the big picture in recent holding changes by foreigners: while Bill holdings by overseas institutions have remained close to their peak at about 40%, foreign Bond holdings have steadily declined from a peak about 65% to the current level of about 50%, even as overall Bond issuance has skyrockted. The Fed's UST purchasing impact has been felt most acutely in the long-dated side of the curve. If China has indeed plateaued, just who will take its place? And no, contrary to December data, the answer is not the UK, who will soon have other major problems to deal with than buying US treasuries.