Fixed-income investors remain transfixed on Treasury yields, trying to second guess when the Federal Reserve might look to rein in its bond-buying program. But strategists have told CNBC there may be another threat on the horizon with China starting to fall out of love with U.S. debt.
Yi Gang, a deputy governor at the People’s Bank of China (PBoC), said in a speech at Tsinghua University on Wednesday that it’s no longer in China’s favor to accumulate foreign-exchange reserves, according to reports by both Bloomberg and the Wall Street Journal.
“The appreciation of the yuan since 2005 has been primarily driven by market forces and overall this has helped improve the welfare of the Chinese people,” he said, but gave no time frame for the change in strategy.
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Analysts see this as the PBoC hinting that it will let its currency fluctuate, without intervention, thus negating the need for holding large reserves of the dollar. And if the dollar is no longer needed, then it could look to curb its purchases of dollar-denominated assets like U.S. Treasurys.
“If they are looking to reduce these purchases going forward then, yes, you’d have to look at who the marginal buyer would be,” Richard McGuire, a senior rate strategist at Rabobank told CNBC in an interview.
“Together, with the Federal Reserve tapering its bond purchases, it has the potential to add to the bearish long-term outlook on U.S. Treasurys.”
China is by far the largest foreign creditor to the U.S., holding just under $1.3 trillion in U.S Treasurys, according to Reuters, and a total of $3.66 trillion held in foreign exchange reserves.
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Twenty years ago China would have kept nearly all its reserves in mostly short-dated government bonds, according to Kit Juckes, global head of foreign exchange strategy at Societe Generale. Despite recent diversification, the Chinese still hold a large slice, he added, and has probably kept U.S. Treasury yields lower by 40 basis points in recent years.
If China does rein in its bond purchases, “yields won’t ‘shoot up’, the curve’s too steep for that,” Juckes told CNBC via email. “But the chances of seeing 3 percent 10 year yields by Christmas have increased.”
Analysts may believe that China could “taper” but they don’t foresee the country selling what it already owns. It’s not in their interest to see Treasury prices decline as they would lose a lot of money, McGuire iterated.
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Neil Mellor, a currency strategist at Bank of New York Mellon told CNBC that China would be very cautious with any decision to taper as “self-interest” would apply and the United States has made progress with its deficit reduction.
“It is entirely possible that Congress may have to cooperate a little more closely and that by the time China is fully ready to taper, the Treasury market is in better shape,” he said via email.
“They may of course decide to taper without due heed to any of these issues – perhaps hoping that the threat will be enough to force the U.S.’ hand; but I think they’re both in it together and must cooperate to some extent. We shall see.”
By CNBC.com’s Matt Clinch. Follow him on Twitter @mattclinch81