A Bloomberg news report on Wednesday said that, based on sources, that China is considering slowing down or even stopping buying U.S. public debt securities.
This sent the Treasury markets into a relatively volatile day, with things eventually settling down as it seems the market judges that this information may lower U.S. debt demand a little bit in the short-term but has little effect in the long-term.
The news may seem worrisome given how China is our largest foreign creditor, and has recently been a major debt buyer. Nonetheless the news is uncertain enough, and China's proportion is not sufficiently dominant, that at the moment it likely offers little worry for bond securities - although it is worth taking note of.
China As One Of America's Largest Creditors - Or Is It?
It's long been said that China (NYSE: FXI) is one of America's largest creditors. It's become a mainstay of popular culture to remark jokingly about how the Chinese government is a major financier of America.
Indeed, according to the U.S. Treasury Department as of October 2017 China holds approximately $1.189 trillion of the $6.349 trillion in U.S. public debt securities (NYSE: TLT) that foreign nations hold.
That accounts for 18.72% of our debt held by foreign entities.
(Figure: Top Foreign Holders of U.S. Debt, In Billions, Source: U.S. Treasury Department)
Sounds scary, doesn't it? However, here's why China's holdings in and of themselves aren't really that meaningful:
Firstly, a quick look at that chart shows Japan owns almost just as much of our debt as China does. Ireland even owns over $312 billion of our debt, and if this is combined with that of Brazil, the Cayman Islands, and Switzerland, the total essentially matches China's ownership.
Therefore even among foreign debtholders, China is indeed a large creditor but not completely dominant. Many foreign nations hold our debt, and China is a big market player but still one of many.
Secondly, on the broader scale, China isn't as major a player in American debt as their proportional ownership of our foreign-held debt makes it seem.
The biggest collective holder of U.S. government debt by far is made up of American companies, institutions, funds, people, and even the government itself. While foreign nations held $6.3 trillion of American public debt in October 2017, the other roughly $13 trillion of that debt at the time was held by the American people.
As of this month, with roughly $20.492 trillion in total public debt, our own federal government actually owns over $5.678 trillion of it (27.70%). The intragovernmental holdings metric doesn't even include state and local governments, let alone American institutions, companies, funds, and residents, which own the rest of the roughly $8 trillion.
(Source: The Balance)
Compared with our overall national debt, China's ownership of a mere $1.12 trillion amounts to barely just over 5% of our national debt.
Seems a lot less scary now, doesn't it?
On The Other Hand...The Chinese Are Increasing Their Treasury Buying
However the asset ownership itself only tells part of the story, as it relates to past debt auctions and buying rather than future likelihood, which is the major determinant for interest rates for upcoming debt securities as our deficit spending and debt rollover continues.
China's rate of accumulating our debt securities is increasing moderately but not at an extraordinary rate. From November 2016 to October 2017, China's ownership of our national debt increased from $1.049 billion to $1.189 billion, or roughly $139.9 billion (+13.33%).
In contrast, our national debt during that time increased from $19.9480 trillion at the end of November 2016 to $20.4424 trillion at the end of October 2017, for an increase of $494.4 billion or 2.784%.
Based on this, it is clear that China's accumulation of our public debt has recently been increasing significantly faster than our own national debt has been increasing.
In looking at this metric from another standpoint, in that time period China's addition of $139.9 billion in U.S. public debt securities amounted to 28.297% of the $494.4 billion that we added. That is significantly higher than their current roughly 5% holding of our debt.
It is worth noting that this accumulation of securities isn't necessarily all from new auctions, but nonetheless the comparison does show the accelerated Chinese buying in comparison to new debt being created, meaning their position is growing bigger in relative terms on multiple fronts and measures.
It seems like the takeaway from this is that while China remains a mildly important yet small U.S. creditor, it recently has been accelerating its proportion both in terms of its own position size as well as in relation to our debt being issued.
Indeed this is slightly worrying, as that means they are at the moment an important customer for U.S. debt securities and that their pullback from that market might cause some decline in demand. That's especially if it's a complete retreat, thus pushing interest rates up during Treasury auctions, and thus bringing bond prices down.
That explains pretty thoroughly the market reaction to the China announcement, as Treasury rates reacted in quite a volatile way in response.
Treasuries Went A Bit Crazy, But Then Settled Down
When the Bloomberg report broke Wednesday morning around 5:00 am, here's how U.S. bond markets reacted:
- The 2-year Treasury yield (NYSE: SHY) (NYSE: VGSH) jumped from 1.969% at 5:20 am to 1.985% (+.016%) at 5:35 am, collapsed, reached a high during the day of 1.993% (+.024%), crashed, and since then have been bouncing around at a slightly elevated level.
- The 10-year Treasury yield (NYSE: IEF) jumped from 2.553% at 5:25 am to 2.571% (+.018%) at 5:30 am, to 2.594% (+.041%) at 5:50 am, held an elevated level throughout most of the early trading day, and then collapsed back to its pre-news levels.
The 5-year (NYSE: IEI) and 30-year also went quite volatile a bit, before the 5-year settled at an elevated level while the 30-year returned to pre-news levels.
As you can see, it seems that Treasuries went a bit crazy initially, but then as the news was processed and analyzed throughout the day it seems things settled down and the announcement had varying impact on Treasury bond yields depending on maturity.
For shorter-dated Treasuries, the announcement resulted in currently the market holding an elevated rate level. For longer-dated Treasuries, the announcement caused some volatility but then the prices rallied back to normal, as if the announcement had almost no impact.
My takeaway is that the market has decided that while the China announcement may have a small chance of increasing U.S. financing costs in the short term, in the long term it is likely to have little impact if any at all.
Indeed if China stopped purchasing U.S. debt securities it might have a significant impact on Treasury demand, especially in the short term.
Yet policy changes over the long term are incredibly difficult to predict, and the news right now is essentially unconfirmed sources who merely say that China is "considering" it.
Even if the Chinese do retreat from the U.S. Treasury market, there are still many creditors and buyers out there, whether here in America or internationally. Rates might indeed see a spike, but with decreased demand from one buyer there is always the possibility of increased demand from another.
For the moment, it seems the bond volatility has settled and rightfully so. For now, we simply don't know what China will do with the lack of an announcement or hard numbers of changes in debt holdings and buying.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.