Asian shares step back from New Year rally as trade concerns resurface

Ellen Mills
January 13, 2018

Economists say they expect China to continue to adjust its holdings of US government debt, considered to be the most liquid dollar assets, but few believe dumping US Treasuries is among policy choices to be considered by top leaders.

It remains the world's largest foreign holder of U.S. government debt, according to the U.S. Treasury Department. The use of Treasury notes as a financial weapon is sometimes referred to as the "nuclear option" in financial markets. Meanwhile, yields on benchmark 10-year Treasuries were now hovering around 2.55%, its highest level since March 2017.

"There is no evidence that China has been "slowing down or halting purchases of US treasuries".

Consequently, some future selling of USA treasuries may be forthcoming by market participants, including from China, as well as elsewhere, because of inflation pressures", say Grace and Haddad.

"We're seeing a lot of overseas buyers who would come in every time we'd have a move close to these levels who aren't coming in anymore", said Michael Franzese, New York-based head of fixed-income trading at MCAP LLC, a broker-dealer.

Germany's 10-year bond yield hit its highest level since the October European Central Bank meeting when policymakers first announced the extension of its bond-buying scheme, with one trader citing heavy supply as the trigger for the move.

In order for bond yields to move higher, bond prices would have to fall as the "coupon" interest payment is fixed at the point when new bonds are issued and can not be changed to compensate for higher (better) base rates.

The debt holdings accounted for 38 percent of China's total reserves, up from 35 percent at the end of 2016.

China's foreign exchange reserves - the world's largest - rose to US$3.14tn in December.

"When they (the BOJ) reduced their bond-buying yesterday, people suddenly thought maybe we've underestimated the BOJ, maybe we should pay more attention to what their future policy path should be like ... and I think it's caused a re-evaluation of risk in bond markets".

In the eyes of some, Chinese officials may be trying to send a message that they have leverage with President Trump talking tough on trade.

Market sentiment seems tilted toward the dollar's downside, said Masashi Murata, currency strategist for Brown Brothers Harriman in Tokyo. "That doesn't mean that it is".

On Wall Street, the banking sector surged, led by shares in JPMorgan and Wells Fargo.

According to Societe Generale analysts, the 3 percent US equity risk premium, essentially investors' compensation for buying riskier stocks over bonds, is well below its 30-year average. A steady exchange rate suggests limited pressure on Chinese authorities to add Treasuries as part of intervening in currency markets.

"The tightening effect of such measures would likely have an impact on how many times the Federal Reserve raises interest rates this year, which is why we've seen a corresponding drop in the dollar", OANDA said.

Of course, regardless of the eventual reason behind such a move, the idea that China's holdings of United States bonds won't still shrink coud turn out to be wrong.

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