China Moves to Shorter Maturity Treasuries Out of Bond Bubble Worries

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.

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  1. Anonymous

    Remember the time when the DOW was making new all time highs when it was actually going broke as we now know.

  2. donebenson

    I assume that China made a capital gain on its sale of longer term treasuries. I wonder if they put their ‘profits’ back into the shorter term treasury bills as well?

  3. Anonymous

    One thing that is clear from Brad’s analysis of the TIC data sort of confirmed when I was comparing the bid to cover ratios of UK gilts across the different maturity dates is that short term government debt is very popular while long term government debt is starting to be shunned. This should show up in the yield curves as the FED fails to get it as flat as they would want. We should then watch TIPS or STRIPS becoming the final bubble before things get really sticky.

    I am glad that Brad is coming round to thinking about what happens when commodities bottom and perhaps the economy begins to turn. Here is what Brad has to say

    That just highlights a bigger issue, one that I don’t think has been settled: How will the world’s remaining current account deficits be financed in the post-crisis world? Right now, they are in some sense being financed by the unwinding of all the pre-crisis bets. And by running down existing stocks of foreign assets. But that process cannot last forever …

    It is quite clear to most outside the US that the trade flow inbalances run a high risk of being unwound with a significant further downturn for the US as a result. Maybe not today or tomorrow, but maybe this year or next with the US government being forced to balance its budget with all the consequences that entails. This also sort of implies a significant devaluation of the dollar could occur with yet another downturn as consumer pockets get squeezed by rising prices of imported goods. As with most governments the US appears so steeped in todays problems they are failing to prepare plans for all the possible scenario’s that the future can throw at them. Perhaps I am being a little unfair and things can be turned around, but it is not a bet I would like to take at this point.

  4. go ahead and sell...I dare you

    What a twist that the largest democracy is now financially depended on a communist country for its well being.

  5. mxq

    I think the point is that china has been sorta the destination for a lot of capital…for a multitude of reasons. But those reasons no longer matter, as everyone needs their capital back, more than anything. I view it as almost a giant redemption on china. This follows with what the post from a few weeks ago said…specifically, it cited a SAFE official warning about abnormal cross boarder flows.

    Pettis recently pointed out that as a result of chinas dollar peg, this sort of money supply drain would nullify the effect of the monetary loosening China is engaging in…shrinking available credit at the worst possible time. (sorry no links…on iPhone…no &&&$@ing cut and paste!!)

  6. Anonymous

    IMO, Pettis was wrong on previous inflation, hot money and money control issue in China. Now he is wrong again on hot money outflow’s impact.

  7. RR

    Anon at 1:29,
    I am with you. Many with more importance than me have said that the potential trade wars, protectionist rhetoric, and unconstructive conflict that prevents effective international coordination is something to watch closely.

    Geithner’s statement is no coincidence. And it is very significant.

    Perhaps more significant will be how China responds (with more critical rhetoric of their own?)


  8. mxq

    anon 1:29…thx for pointing that out ->

    i get the feeling that the bush regime didn't want to be labeled as the pot calling the kettle black. But at this point, Obama's gotta be wondering "if china reacts unfavorably to accusations…what are they gonna do…not buy treasuries? and then what? buy Euros instead? That would go over REAL well with the EU (not)…the second biggest exporter manipulating the largest exporter in order to take exporting share"

  9. Anonymous

    China is hedging the US threatening to print…keep your enemies closer and your duration shorter

  10. Anonymous


    Buy oil, metal, or many real stuffs other than US papers. Now the prices are low and it is good time to hoard commodities. And those commodities exporting countries then have money to buy Chinese goods hopefully.

  11. Anonymous

    Yeah I have to agree. This is obviously China hedging bet on Obama flooding the planet with gigantic amount of short term treasury. (eg. crazy inflation similar to late 2006)

    So this time around they will do the exact opposite. They will get cash and burn the source of inflation (US printing press) They won’t get stuck in 30 yrs treasury again. They will play cash with cash.

    I think this is quite natural, everybody anticipate what will happen with US $2T budget deficit. All those new cash.

    The chinese won’t eat the inflation again like before.

  12. john bougearel

    Actually a smart move by China, however, if they did not continue the same strategy in Dec and Jan, they missed the move from 128 ate end of Nov to 143 in mid-Dec. The 30 year’s return move to date is 129-10, only now returning the Nov high at 129-19

  13. DanyBoy

    I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around [the banks] will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs.
    ~Thomas Jefferson, Letter to the Secretary of the Treasury Albert Gallatin) (1802)

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