“In the age of Trump, America’s biggest foreign creditors are suddenly having second thoughts about financing the US government,” surmised a February 13 Bloomberg article with the catchy title “America’s biggest creditors dump Treasuries in warning to Trump.” And further: “From Tokyo to Beijing and London, the consensus is clear: few overseas investors want to step into the US$13.9 trillion US Treasury market right now. Whether it’s the prospect of bigger deficits and more inflation under President Donald Trump or higher interest rates from the Federal Reserve, the world’s safest debt market seems less of a sure thing – particularly after the upswing in yields since November.”
About the only thing in these two loaded sentences that’s unambiguously correct is the statement that there has been an upswing in US Treasury yields since November … and that is amply explained by perfectly rational expectations that Trump’s announced tax cut and infrastructure policies will lead to higher growth and — possibly —higher inflation and Fed policy rates.
On the negative, political side, the Bloomberg story could well serve to revive and play into latent long-standing paranoid fears that the large Japanese and Chinese Treasury holdings will at one point or another be used to politically blackmail the US government by threatening to sink the Treasury market.
So here are the – contrary – facts of the matter.
There is no detectable relationship between the Federal Reserve’s holdings of Treasury securities for foreign central banks and US yields. As the chart shows, Treasury yields fell steadily while foreign central banks (mainly China) reduced reserves during late 2015 and late 2016. Treasury yields jumped after the US presidential election, at a time when foreign central bank holdings actually rose slightly.
This doesn’t exactly repeal the laws of supply and demand. But a one-sided focus on central bank reserves, as in the Bloomberg story, completely misses the point: China was a net seller of dollar assets while the yuan was strengthening against the US currency for the simple reason that Chinese borrowers expected to pay back their dollar debts more cheaply.
When the dollar began to weaken in 2015, Chinese borrowers bought the greenback to repay their dollar debts. The central bank accommodated the private sector by selling them dollars. All of this has been fully explained by Bank for International Settlements economists in March last year.
There is no reason to expect central bank purchases as such to have any effect on dollar interest rates and hence US economic fortunes. It all depends on context. During 2003 and 2004, massive intervention by foreign central banks to prevent the depreciation of the dollar had an impact on US Treasury yields. But presently we find no impact and all the econometric tests available can’t torture it out of the data.
Private flows into and out of Treasuries overwhelm official flows: investors need not worry that PBOC and BOJ decisions on their reserve holdings will negatively impact their investments.
Uwe Parpart is Editor of Asia Times and chief strategist for Capital Link International in Hong Kong.