MARKET SIGNALS-China loses some of its taste for U.S. Treasuries

BEIJING Wed Feb 17, 2010 4:44am EST

BEIJING Feb 17 (Reuters) - China has cut its stockpile of U.S. Treasuries in recent months, an indication that Beijing may be willing to act on fears about Washington's stewardship of the economy by unloading U.S. debt.

The reduction comes amid a recent flare-up in tensions between China and the United States on issues ranging from trade to currency policy and human rights. But before investors hit the panic button about the future of the Treasuries market, China's moves should be seen in a wider context.

China's selling of U.S. government debt only goes part way to reversing its vast purchases of Treasuries at the height of the global financial crisis last year as investors piled into safer assets. And because Beijing sometimes uses accounts in London and elsewhere, it's hard to get a clear picture of its buying.

Moreover, the dollar's rally over the last three months may rekindle Beijing's appetite.

But for all the talk of Washington's dependence on Beijing's buying of Treasuries, it is clear that China's importance in the U.S. debt market may not be what it used to be.

China sold more than $34 billion of Treasuries in December, according to U.S. data on Tuesday. [ID:nN16219791]. It now owns $755.5 billion of U.S. government debt, falling behind Japan to become the second-largest holder of U.S. Treasuries.

December's sell-off was unusually steep, but it was consistent with a trend stretching back to April. China, in net terms, appears to have stopped buying U.S. government debt for eight months running.

For graphic of China's and Japan's Treasury holdings, click: link.reuters.com/tav79h

DISGUISING FLOWS

To a certain extent, China may be disguising it acquisitions of Treasuries. Since May, while China's buying has dwindled, purchases by Hong Kong and London have taken off. Up to 50 percent of acquisitions through these financial centres have in the past been attributed to China.

Later this year, the U.S. Treasury will likely re-apportion some holdings from Britain, Hong Kong and other countries to China. However, the overall picture will still be much the same: Beijing will be shown to have lost some of its taste for U.S. government debt.

For graphic of the divergence in buying, click on: link.reuters.com/kat89h

COMPOSITION CHANGING

Despite China's flat Treasury holdings in net terms, the country's reserve managers have clearly been busy in changing the composition of their portfolio.

At the height of the financial crisis, it almost exclusively bought short-term paper. Since March 2009, when the green shoots of recovery first started showing, it has sold off its short-term positions and favoured long-term notes with higher yields.

But that still raises the question of why China has stopped adding to its Treasury holdings.

For a chart showing the composition of China's reserves, see: link.reuters.com/cut89h

NORMALISING ITS PORTFOLIO?

One possibility is that China is simply normalising its portfolio weightings.

Until the financial crisis, there was a solid correlation between growth of China's FX reserves and growth of its Treasury holdings. Starting in September 2008, these diverged massively: China's FX inflows dried up but its acquisitions of Treasuries went through the roof. This divergence has gone into reverse since roughly April of 2009.

For a chart showing the changes in China's FX reserves against changes in its Treasury holdings, click: link.reuters.com/hut89h

IS CHINA SENDING WASHINGTON A SIGNAL?

There is a very good fit between the dollar's trade-weighted index and China's pace of Treasury buying. When the dollar is strong, China buys more Treasuries and vice-versa.

To see that correlation click: link.reuters.com/jut89h Could this be China's way of telling the United States to follow a strong-dollar policy?

There may also be an element of Chinese domestic politics at play. Given Beijing's criticism of U.S. policies and its oft-expressed worries about the dollar, the government might appear weak at home if it nevertheless continued to buy loads of U.S. debt.

DOES CHINA MATTER?

It is often taken as given that the United States is reliant on - and vulnerable to - China as the biggest foreign holder of Treasuries.

But the massive debt issuance by the United States over the past year, coupled with China's slowdown in buying, has changed some of the facts on the ground. Whether expressed as a proportion of outstanding public debt or foreign-held debt, China's importance in the Treasuries market has diminished.

Tuesday's data also showed U.S. Treasuries of all maturities still attracted a net inflow of $69.9 billion in December.

For a chart showing China's weight in foreign holdings of U.S. debt, click: link.reuters.com/kut89h

(Editing by Vidya Ranganathan & Kim Coghill)

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