Thread: The Numbers Are In: China Dumps A Record $94 Billion In US Treasurys In One Month

The Numbers Are In: China Dumps A Record $94 Billion In US Treasurys In One Month



Submitted by Tyler Durden on
09/07/2015 08:22 -0400

Shortly after the PBoC’s move to devalue the yuan, we noted with some alarm that it looked as though China may have drawn down its reserves by more than $100 billion in the space of just two weeks. That, we went on the point out, would represent a stunning increase over the previous pace of the country’s reserve draw down, which we’ve began documenting months ahead of the devaluation (see here, for instance). We went on to estimate, based on the estimated size of the RMB carry trade unwind, how large the FX reserve liquidation might need to be to offset capital outflows and finally, late last week, wesuggested that China’s official FX reserve data was set to become the new risk-on/off trigger for nervous, erratic markets. In short, the pace at which Beijing is burning through its USD assets in defense of the yuan has serious implications not only for investors’ collective perception of market stability, but for yields on core paper, for global liquidity, and for US monetary policy.

On Monday we got the official data from China and sure enough, we find out that the PBoC liquidated around $94 billion in reserves during the month of August to $3.557 trillion (the lowest since September 2013)...



... and as Goldman argues (see below), the "real" figure might have been closer to $115 billion. Whatever the case, it’s a staggering burn rate and needless to say, were the PBoC to continue to liquidate its assets at this pace, it would necessitate a raft of RRR cuts and hundreds of billions in short-term liquidity ops to ensure that money market don’t seize up in the face of the liquidity drain.
Here’s some commentary from across sellside desks on the official numbers:

• From RBC’s Sue Trinh:
• 
  
  • China FX reserves suggest about $140b used to defend yuan in April once valuation is accounted for
  • Believes PBOC has been intervening to maintain the yuan’s stability since the devaluation, but this kind of intervention can’t continue indefinitely
  • It’s unsustainable in the long run; yuan is overvalued by around 15% by RBC’s latest estimate; still targeting USD/CNY at 6.56 by year-end and 6.95 by the end of 2016
  
  
• From Commerzbank’s Zhou Hao:
• 
  
  • Decline in foreign reserves clearly suggests China’s central bank intervened intensively in the FX market to stabilize CNY exchange rate
  • “One-off devaluation” in mid-Aug. triggered market expectations of further CNY deprecation, which has not only endangered the financial stability, but also posts a downside risk to the economy due to capital outflows
  • It’s costly because frequent intervention will burn foreign reserves rapidly and tighten the onshore market liquidity; that said, further tightening of regulations is expected near term
  • Expects spread between CNY and CNH is likely to persist as PBOC has become an active player in onshore market
  
  
• From Goldman:
  
  • The People’s Bank of China (PBOC) reported that its foreign exchange reserves dropped by US$94bn in August, to US$3.557tn at the end of the month. However, it is not straightforward to derive the actual scale of FX reserves sales from the headline FX reserves data, given uncertain valuation effects and possible balance sheet management by the PBOC.
  • It is possible to get an approximate sense about valuation effects stemming from currency movement: e.g., assuming the currency composition of the PBOC’s FX reserves broadly follows that of the average country’s (using the IMF COFER weights, which suggest roughly 70% in USD for EM countries), the currency valuation effect would probably be positive to the tune of roughly US$20bn (i.e., if we only look at the change in headline FX reserves as a gauge of sales of FX reserves, sales of FX reserves might have been underestimated by around US$20bn, given the currency valuation effect). However, besides currency movements, there could also be significant valuation effects from changes to the market prices of the PBOC’s investment portfolios, and the direction and size of those effects is hard to measure given the uncertainty of the asset composition. Moreover, there could also be possible short-term transactions and agreements between the PBOC and banks that may complicate the interpretation of the change in FX reserves as an underlying measure of RMB demand.

Of course the huge draw down was widely anticipated and indeed, we've explored and detailed virtually every angle of this story in the lead up to the data. The key takeaway here is that we now have official confirmation that August saw $94 billion in reverse QE (and more likely $115 billion) or, quantitative tightening as Deutsche Bank puts it.

We can, as we explained on Saturday, argue about what the ultimate effect on safe haven assets will be, but what's not up for debate is that conceptually speaking, China's massive UST dumping is the opposite of Western central bank QE and as such should be expected to pressure yields. More specifically, Citi has suggested that for every $500 billion in EM FX reserve liquidation, there's an attendant 108 bps or so of upward pressure on 10Y yields. Similarly, Deutsche Bank, citing the extant literature, flags 50-60bps of upward pressure on 5Y yields for every $100 billion in monthly EM FX reserve liquidations.

The takeaway, as we put it last week, is that if the Fed hikes this month, it will be tightening into a tightening.

But it's not that simple. It's also possible that, if China's FX reserve draw downs do indeed end up serving as a trigger for risk-off behavior (i.e. a selloff in risk assets), the subsequent flight to safety could end up driving yields on long bonds lower, not higher. We discussed this in detail over the weekend.

Still, China isn't the only country liquidating its USD assets. When you consider that global EM FX reserves amount to more than $7 trillion, it seems reasonable to ask whether the flight to safety that would invariably accompany a worldwide selloff in risk assets would be sufficient to replace the lost bid from massive reserve draw downs. Or, as we put it on Saturday, "the real question is what would everyone else do. If the other EMs join China in liquidating the combined $7.5 trillion in FX reserves (i.e., mostly US Trasurys but also those of Europe and Japan) shown below into an illiquid Treasury bond market where central banks already hold 30% or more of all 10 Year equivalents (the BOJ will own 60% by 2018, then it is debatable whether the mere outflow from stocks into bonds will offset the rate carnage."

And that consideration, in turn, puts the Fed in a very, very difficult spot. A rate hike cycle will put further pressure on already beleaguered EM currencies which raises the possibility that the FX reserve liquidation will be larger than the eventual safe haven flows and besides, there's bound to be a lag between the liquidation of USD assets and the flight to safety and given the potential for extraordinary bouts of volatility in UST, JGB, and German Bund markets, it's anyone's guess what happens in between.

Whatever the case, something will have to give here. That is, all of these dynamics (i.e. a Fed hike, China's massive UST dumping, an EM meltdown precipitating FX reserve drawdowns, illiquid markets for the same assets everyone is dumping, hemorrhaging petrostate budgets, etc.) simply cannot coexist for long without something snapping because, as we put it last week, in this very unstable arrangement, the smallest policy error will reverberate exponentially, and those reverberations can lead to only one thing: the Fed's admission of policy failure by adopting a tightening bias, and ultimately launching another phase of monetary easing, be it QE4 or perhaps even the long-overdue and much anticipated Friedmanesque "helicopter money" episode.
http://www.zerohedge.com/news/2015-0...urys-one-month

China’s Selling of U.S. Treasurys Doesn’t Matter

We shouldn’t confuse central bank sales with China’s activity as a whole.

By MICHAEL PETTIS
Sept. 7, 2015 12:55 p.m. ET 1 COMMENTS

China’s foreign-currency reserves fell by nearly $94 billion last month, a record that results from Beijing’s efforts to support the value of its currency, the renminbi, and to limit currency outflows as the economy slows. This has led to widespread worry about a disruptive effect on U.S. interest rates, as the world’s largest buyer of U.S. government and agency bonds suddenly becomes a major seller.

But there is less here than meets the eye.

For more than two decades China’s large current-account and capital-account surpluses have powered the accumulation of foreign-currency reserves at the nation’s central bank, the People’s Bank of China. Reserves peaked at $4 trillion, the second-largest accumulation in history, as the PBOC became the world’s largest buyer of U.S. bonds. But since last year the PBOC has reversed its position and is now, for the first time in decades, reducing its lending to the U.S. government.

To many this seems unnerving, but shouldn’t. While the PBOC can choose which assets it will buy and sell, it has no discretion over how much it will buy or sell in total. Like with any central bank that sets the value of its currency, the PBOC’s reserves simply rise or fall by whatever amount is necessary to balance the country’s current and capital accounts.

We shouldn’t confuse buying and selling by the PBOC with buying and selling by China as a whole. By definition, the sum of net investment into or out of China and the change in PBOC reserves balances China’s current-account surplus. Because we know that this surplus has been rising in the past two years, we also know that Chinese entities, which include the central bank, have recycled increasing amounts abroad.

ENLARGE
PHOTO: GETTY IMAGES/ISTOCKPHOTO


For decades, investment inflows far exceeded investment outflows, so the PBOC was forced to increase its reserves by the sum of the capital account and current account inflows. In 2014, as inflows dried up and outflows accelerated, China for the first time ran a deficit on the capital account large enough to balance the current account surplus, so the PBOC neither bought nor sold a substantial amount of reserves.

This trend accelerated in 2015, with investment outflows exceeding investment inflows by so large a margin that it was greater than the current-account surplus. As a result, the PBOC has had to sell a substantial amount of reserves.

Roughly two-thirds of China’s foreign-currency reserves are believed to be held in dollar assets, which implies that the PBOC sold hundreds of billions of dollars of U.S. bonds. We don’t have a precise breakdown of the composition of central bank sales or of other Chinese purchases, but anecdotal evidence suggests that a substantial amount of these purchases end up in the U.S. directly or indirectly.

If the PBOC maintains two-thirds of its reserves in dollar obligations, Chinese investment in the U.S. will actually increase, not decrease, if other Chinese entities direct one-half to two-thirds of their outward investment to the U.S.

We cannot be sure if Chinese entities are increasing or reducing their holdings in the U.S., but it’s pretty easy to determine whether foreigners as a whole are doing so. Because the U.S. is running a current-account deficit, we know by definition that foreigners—if not Chinese, then others—are net buyers of U.S. assets. And if the U.S. current-account deficit increases, then foreigners are buying larger amounts than ever.

And there’s the rub. Contrary to widespread perceptions, net foreign purchases of U.S. assets are not necessarily something to be welcomed, as they are simply the obverse of the U.S. current account deficit. The larger one is, the larger the other is too.

Some economists argue that net foreign investment is necessary to bridge the American savings deficit. They are wrong.

Counterintuitive as it seems, net foreign investment actually creates the American savings deficit, so it is usually inimical to growth for the U.S. and indeed for any economy in which productive investment is not constrained by the lack of savings. This is true in fact for almost any advanced economy. For much of the 19th century this constraint held in the U.S., and net foreign investment boosted U.S. growth. But for most of the past 100 years it has not.

So while it is certainly true that the PBOC is selling U.S. government bonds after many years in which it was the world’s largest buyer, there is no reason for Americans to worry. The PBOC is only selling because other Chinese are buying. And even if other Chinese and other foreigners were net sellers, this would only mean that the U.S. current account deficit were falling. That might cause U.S. interest rates to rise, but only by spurring U.S. growth. Which is no reason for panic.

Mr. Pettis is a finance professor at Peking University and a senior associate at the Carnegie Endowment.

http://www.wsj.com/articles/chinas-s...ter-1441644918