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The yuan’s decline to a decade-low has analysts and investors casting a wary eye toward China’s $1.1 trillion pile of U.S. Treasuries.
The idea that China -- America’s biggest foreign creditor -- would dump its U.S. debt holdings wholesale as a way to retaliate in the trade war is often dismissed as improbable. For one thing, analysts say, there aren’t many other viable places for it to park its $3.1 trillion in currency reserves.
However, the yuan’s plunge on Monday past 7 per dollar -- long seen as a line in the sand for Chinese authorities -- shows the possibility can’t be ruled out, according to Stephen Roach, a senior lecturer at Yale University. China has “plenty of ammunition” and is operating on a longer time-frame than U.S. President Donald Trump, he said.
“Most people didn’t think they’d use the currency weapon and they’ve used that, and used it surgically.” said Roach, former chairman of Morgan Stanley Asia. “So conceivably, they might consider other options, and you can’t rule out the Treasuries option.”
China has already been trimming its Treasuries holdings, which are now the smallest in about two years and about $200 billion below their 2013 peak. But Monday’s developments spurred speculation they could shrink further.
China’s offshore yuan slumped as much as 1.9% to a record low of 7.1114 per dollar Monday. The drop drew fresh criticism from Trump, who decried it as “currency manipulation” in a tweet and indicated he’d like the Federal Reserve to counter it.
The breach of 7 signifies a “huge shift” in Chinese policy makers’ thinking and raises the risk that they’ll weaponize their Treasuries stockpile, in the eyes of Sebastien Galy at Nordea Investment Funds.
There’s little sign that investors are shunning U.S. debt. Benchmark 10-year yields dropped to 1.71% Monday -- the lowest since 2016 -- as investors sought shelter amid the trade tensions.
Galy said he’ll be watching this week’s U.S. debt auctions for signs of a Chinese pullback. The U.S. is scheduled to offer a combined $84 billion of 3-, 10-and 30-year securities from Tuesday to Thursday.
“Once China doesn’t show up in the direct auction bids, the U.S. Treasury will know it,” said Galy, senior macro strategist Nordea. “And their bids via indirect bids -- through the banks -- if China doesn’t show up, the banks will know it immediately.”
However, any large-scale Chinese selling of Treasuries could work against any effort to push the yuan weaker, according to Exante Data LLC founder Jens Nordvig. That’s because unloading Treasuries would by definition mean selling dollars, which would support the Chinese currency’s value.
Regardless, the yuan’s tumble past 7 signals that the trade dispute is far from resolved, Nordvig said.
“It seems to me that China has given up on negotiating for real and playing nice on the FX,” Nordvig said. “This is a new regime.”
--With assistance from Sophie Caronello.
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