China Can’t Escape Treasuries Despite a Mini-Boycott

(Bloomberg Opinion) -- China is reportedly venturing into other bond markets besides U.S. Treasuries to invest its troves of dollars. Perhaps paradoxically, it should provide relief to those concerned about a full-fledged buyer’s strike by America’s largest foreign creditor.

Every time trade tensions escalate between the world’s two largest economies, the inevitable question becomes whether China will weaponize its $1.12 trillion of Treasuries, flooding the market and causing interest rates to surge. And every time, onlookers like myself and others explain why that’s extremely unlikely to happen. The country has $3.1 trillion of foreign-exchange reserves that have to go somewhere, after all.

That doesn’t mean China can’t at least try to tilt away from the U.S., though. Reuters reported this week that the country appears to be expanding into dollar-denominated debt from other top-rated sovereign-like agencies:

At least four investment banking officials who deal with public sector debt report a spike in interest from China in government-linked borrowers, who can offer an alternative to U.S. Treasuries.

Prominent among these are the European Investment Bank, a development bank backed by European Union countries, KfW, a German government-guaranteed institution and AIIB, a Beijing-based pan-Asian development bank that issued its first ever bond last month.

While bond buyers are publicly identified only by geography or category, bankers reckon recent Asian buying is led by China.

As far as I can tell, this shift barely registered in the minds of bond traders. That’s probably because it simply reinforced the futility of China escaping its reliance on the Treasury market. If this is a boycott, it’s a mini-boycott at best.

Consider AIIB, the Asian Infrastructure Investment Bank, based in Beijing. It issued $2.5 billion of five-year debt last month. It said it received orders of more than $4.4 billion from more than 90 bidders across 27 countries. About three weeks later, the U.S. sold 16 times as much in five-year Treasuries. It’ll do so again this month. And the month after. And the month after that. I could go on.

These other borrowers simply don’t have the scale for China to realistically shun the $15.9 trillion Treasuries market. Even if it could somehow buy up all the outstanding dollar debt from the European Investment Bank and KfW, which have obligations dating back to the turn of the century, that still only comes to about $250 billion.

More realistically, China would have to slowly build up its holdings through new deals. The EIB most recently issued $3 billion of five-year securities in May, while KfW sold $3 billion of two-year bonds in April. Indeed, according to Reuters, Asian buyers bought 51% of that EIB bond issue, compared with a share of 30% to 38% on the bank’s dollar deals last year. Even if that was entirely China, it still adds up to little more than a rounding error.

Bond traders who saw such a shift coming from China could have made a tidy profit if they positioned accordingly. The spread between five-year Treasuries and EIB debt due in March 2024 has narrowed to 10 basis points from as much as 20 basis points soon after the EIB issued the securities in January, data compiled by Bloomberg show. And that’s even with five-year Treasuries soaring (and yields plunging) on expectations of impending Federal Reserve interest-rate cuts. That sort of outperfomance has been a trend for years, though, so added demand from China simply kept the momentum going.

The Reuters report states that “any Chinese move to slowly diversify reserve investments could prove problematic for the United States,” given how much debt the federal government has maturing in the coming years. But that’s just not the case. Even as the Fed reduced its balance sheet, and foreign buyers failed to accelerate their purchases at the same pace as the Treasury borrowed to cover the Trump administration’s swelling budget deficits, domestic buyers have picked up the slack. No auctions have come anywhere close to struggling — and, as I’ve written, a single lousy one doesn’t say much at all anyway.

All this demonstrates why anyone still worried about China’s massive stockpile of Treasuries should breathe a sigh of relief. Even if China wanted to, it just can’t quit the U.S. debt market.

To contact the editor responsible for this story: Daniel Niemi at dniemi1@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.

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