March 1, 2011 / 9:00 PM / 8 years ago

China seen as risk as holdings surpass $1 trillion

NEW YORK (Reuters) - China may have more potential than ever to influence U.S. debt prices after data showed the country owns more than a $1 trillion in Treasuries, almost a third more than previously thought.

Treasury Department data released on Monday showed that China held $1.16 trillion in U.S. government debt in December, the most recent month for which figures are available, up from prior estimates of $892 billion.

The revision came as investors are increasingly scrutinizing the world’s largest holder of U.S. debt for any signs it may accelerate selling of U.S. government bonds.

China reduced its net Treasuries holdings by $15 billion in the last quarter of last year.

Some investors believe the effect of China reducing its holdings has already been felt in the market.

“The selling has had an impact as seen by the higher yields since October,” said Russ Certo, co-head of rate trading at Gleacher & Co in New York. “I think at these levels, China will have less of a relative impact but it will continue to impact the market going forward.”

Rates have risen from almost two-year lows reached in October, when the Federal Reserve announced it would buy an additional $600 billion in bonds to help stimulate the economy, a program known as QE2.

Benchmark 10-year note yields, for example, rose as high as 3.74 percent last month, from 2.40 percent before the QE2 announcement. The notes traded on Tuesday with yields of 3.49 percent.

Two-year notes were last up 1/32 in price to yield 0.67 percent, down from 0.69 percent late Monday, and five-year notes rose 4/32 in price to yield 2.13 percent, down from 2.14 percent.

Thirty-year bonds rose 4/32 in price with yields little changed at around 4.49 percent.

There is no way to quantify how much of the yield increase can be attributed to China, and the country’s selling has so far been small relative to its overall ownership of bonds.

It would also be difficult for China to unload a large amount of debt without hurting itself through the reduced valuations of its remaining holdings.

That, however, has not stopped people from worrying about its potential influence. For more, see: nN16107516.

Some analysts have even theorized that the QE2 program may have been conceived as a way to provide a bid for U.S. debt as Fed officials anticipated Chinese selling.

China has had to purchase vast amounts of U.S. assets to keep its currency from rising against the dollar. Some analysts believe this will likely to continue to make Treasuries attractive to Chinese policymakers.

“The constant fear whenever anybody owns a lot of anything is that it can only go in one direction and that’s back down,” said Jim Vogel, interest rate strategist at FTN Financial in Memphis, Tennessee.

“Our long-term view has been that there’s not going to be sales. There’s going to be more than likely continued re-investment of interest income,” he said.

Others, however, see China as increasingly likely to allocate funds to assets other than Treasuries.

“They have clearly lightened up, as have others, which can be seen by the strategic deployment of cash to other products like commodities and other non-dollar pursuits,” said Gleacher’s Certo.

“They do have some dollar needs and they are expressing them. But they are probably expressing them with a diversity of asset classes, such as private equity investments, or M&A. They do participate in U.S. fixed income, but to a lesser extent than they did,” he added.

Editing by Dan Grebler

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