The 30 year Treasury bond has fallen from roughly 140 to its current level of 125-ish, so absent an intensification of deflation worries, one might surmise that at least some of the air has come out of the Treasury bond bubble.
One might also take the view that the Chinese played this one astutely (or perhaps even contributed to the fall in price). As Brad Setser noted in his comments on the Treasury International Capital report for November:
China sold $9.2 billion of long-term Treasuries. But it also bought $38.2b of short-term Treasuries. China’s total Treasury holdings are up by $29.1b. By contrast it sold $3.1b of long-term Agencies and also reduced its short-term holdings by about $5 billion. China reallocated its US portfolio, but it hasn’t cut back on its dollar purchases.
China Stakes (hat tip reader Michael) argues that China needed to hold a higher proportion of instruments with less price risk (ie shorter maturities) so as to give them more flexibility to contend with the exodus of hot money and to reduce exposure to the risk of a fall in Treasury bond prices (the long maturities are the most volatile).
From China Stakes:
The global financial market worsened since the fourth quarter of last year, and capital was looking for risk shelters. China followed suit by making adjustment to the term structure of its holding of the US treasury bills. It successively sold some short-term bills in the first quarter of 2008, but began to buy in the fourth quarter….Moreover, China has also begun to increase its holding of American assets with higher risk. Last November, China increased its holding of US mid and long-term corporate bonds by $170 million. During September and November, China bought US shares worth $49 million, $130 million, and $710 million respectively.
However, China is still selling off long-term government-backed institution bonds. Brad Setser, researcher at the Council of Foreign Relations found that China has sold $3.1 billion of long-term US treasury bills and $5 billion short-term dollar institution bonds.
China is unlikely to exchange its dollar assets for assets in other currencies, but might swap long-term bonds for short-term bonds. The market worries that the USD appreciation and price hike of US treasury bills since the third quarter of last year was largely due to that capital flew back to the US to seek risk shelters, especially to the US treasury bonds market since last September. Therefore, with the market stabilizing, the price of US treasury bonds may fall back….
China’s capital outflow in the fourth quarter last year was estimated at about $160 billion. China has about $200-300 billion cash in its foreign exchange reserve of over $1.9 trillion. More future capital outflow may force China’s central bank to sell its dollar assets to meet domestic demand of cash exchange, and this will lead the central bank to adjust its portfolio of foreign exchange reserve by selling long-term treasury bills and buying short-term ones.