A toxic trifecta for bondholders.
China’s holdings of US Treasury securities plunged by a stunning $66.4 billion in November 2016, after having already plunged $41 billion in October, the US Treasury Department reported today in its Treasury International Capital data release. After shedding Treasuries for months, China’s holdings, now the second largest behind Japan, are down to $1.049 trillion.
At this pace, it won’t take long before China’s pile of Treasuries falls below the $1 trillion mark. It was China’s sixth month in a row of declines. Over the 12-month period, China slashed its holdings by $215.2 billion, or by 17%!
Japan’s holdings of US Treasuries dropped by $23 billion in November. Over the 12-month period, its holdings are down by $36.3 billion.
But we don’t really know all the details. We only get to see part of it. This data is collected “primarily,” as the Treasury says, from US-based custodians and broker-dealers that are holding these securities. Treasury securities in custodial accounts overseas “may not be attributed to the actual owners.” These custodial accounts are in often tiny countries with tax-haven distinctions. And what happens there, stays there. The ones with the largest holdings are (in $ billions):
The UK is on this list because of the “City of London Corporation,” the center of a web of tax havens.
Total holdings by foreign entities, including by central banks and institutional investors, fell by $96.1 billion in November. China’s decline accounted for 69% of it, and Japan’s for 24%.
This says more about China than it says about the US, or US Treasuries, though November was a particularly ugly month of US Treasuries, when the 10-year yield surged from 1.84% to 2.37%, spreading unpalatable losses among investors. This surge in yields and swoon in prices wasn’t ascribed to China’s dumping of Treasuries, of course, but to the “Trump Trade” that changed everything after the election.
But China’s foreign exchange reserves have been dropping relentlessly, as authorities are trying to prop up the yuan, while trying to figure out how to stem rampant capital flight, even as wealthy Chinese are finding ways to get around every new rule and hurdle. Authorities are trying to manage their asset bubbles, particularly in the property sector. They’re trying to keep them from getting bigger, and they’re trying to keep them from imploding, all at the same time. And they’re trying to keep their bond market duct-taped together. And in juggling all this, they’ve been unloading their official foreign exchange reserves.
They dropped by $41 billion in December to $3.0 trillion. They’re now down 25% from $4.0 trillion in the second quarter of 2014. That’s a $1-trillion decline over 30 months! What’s included in these foreign-exchange reserves is a state secret. But pundits assume that about two-thirds are securities denominated in US dollars (via Trading Economics):
Japan and China remain by far the largest creditors of the US, and the US still owes them $2.16 trillion combined. But that’s down by $90 billion from a month earlier and down $251 billion from a year earlier. And it’s not because the US is suddenly running a trade surplus with them. Far from it. But it’s because both countries are struggling with their own unique sets of problems, and something has to give.
The fact that the two formerly-largest buyers of US Treasuries are no longer adding to their positions but are instead shedding their positions has changed the market dynamics. And both have a lot more to shed! This is in addition to the changes in the Fed’s monetary policy – now that the tightening cycle has commenced in earnest. And it comes on top of rising inflation in the US. These factors are forming a toxic trifecta for Treasury bondholders.
This trade was just waiting to unwind. Read… The Dollar, “the Most Crowded Trade,” Gets Less Crowded