Markets Say U.S. Doesn’t Need China—or Fed—to Buy Its Debt

(Bloomberg) -- A specter is supposedly haunting U.S. bond markets: The prospect that China, which holds $1.11 trillion of Treasuries, could weaponize them in its trade war with President Donald Trump.

With U.S. 10-year yields plunging toward 2%, the day after the Treasury said Chinese holdings shrank to a two-year low, the phantom is looking a bit faint -- and a closer look at the data may help to dispel it altogether.

The concern is that if the People’s Bank of China decided to dump Treasuries, it would send U.S. interest rates spiking higher, just when Trump’s administration is borrowing more.

A real-time experiment provides some evidence of what happens when a major central bank cuts back on its Treasury holdings. In this case, the actor is America’s own Federal Reserve.

The Fed has shed about $350 billion in U.S. government debt from its balance sheet since late 2017. There’s been little sign of alarm on bond markets. More like the opposite. For most of the past year, yields have been falling -- more or less in lockstep with the Fed’s offloading.

Not Dependent

The portfolio trim -- known as quantitative tightening -- hasn’t involved selling bonds into the market, as the Fed’s Chinese counterpart potentially could. Still, the operation might have been expected to push yields up.

That’s because when the Fed was keeping its balance sheet steady, it made purchases via non-competitive bids outside of the main auctions, to replace its maturing holdings. When it stopped doing so, the result was a funding gap for the U.S. Treasury -- one that had to be filled by selling more debt to someone else.

Which, it turned out, wasn’t a problem.

The idea that the U.S. is dependent on foreigners to float its deficits has been quietly taking a hit too. Overseas central banks haven’t been significant net buyers for a while.

As government bond sales break records, it’s mostly been private domestic investors who snapped them up, with the Fed out of the game and its foreign counterparts largely on the sidelines.

The picture is even clearer when looking at foreign holdings as a proportion of America’s national debt, instead of dollar numbers. The share has steadily declined.

China is still America’s biggest creditor, according to the latest data. But its portfolio of Treasury bonds, notes and bills has shrunk to 17% of the total amount of those securities held overseas -- or 5% of the overall national debt.

The debt holdings trimmed by the Fed represent only about one-third of what the PBOC could potentially unleash. Rumor that China might slow or halt its purchasing of Treasuries, let alone sell them, has caused market flutters before.

But few analysts think that Chinese dumping is a plausible scenario. Some question whether it would be in China’s interests -- or if the move might ultimately rebound in America’s favor.

To be sure, ever-larger deficits could eventually push markets to a tipping point. So far, though, the demand for U.S. government debt has proven durable, even without the Fed and other central banks as big buyers.

That’s been a corrective for economists who were convinced that more borrowing would inevitably spell higher yields -- and a damper for some of the alarm bells about debt dependence on foreigners.

--With assistance from Liz Capo McCormick.

To contact the reporters on this story: Alex Tanzi in Washington at atanzi@bloomberg.net;Ben Holland in Washington at bholland1@bloomberg.net

To contact the editors responsible for this story: Alex Tanzi at atanzi@bloomberg.net, Sarah McGregor

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