China Cuts Long-Term Treasuries By Most Ever as Yields Drop

By Wes Goodman and Daniel Kruger - Aug 17, 2010

China cut its holdings of Treasury notes and bonds by the most ever, raising speculation a plunge in U.S. yields that sent two-year rates to a record low has made government securities unattractive.
The Asian nation’s holdings of long-term Treasuries fell by $21.2 billion in June to $839.7 billion, a U.S. government report showed yesterday. Total Chinese investment in U.S. debt declined 2.8 percent to $843.7 billion, the least in a year, following a 3.6 percent slide in May.

China, America’s largest creditor, is cutting back after scrapping its currency peg in June, giving it less reason to buy dollars and invest them in Treasuries. China is also turning more bullish on Europe and Japan, purchasing bonds of both nations. The shift comes as President Barack Obama increases U.S. debt to record levels, counting on overseas investors to buy, as he borrows to sustain the U.S. economic expansion.

“This may have been opportunistic,” said James Caron, head of U.S. interest-rate strategy in New York at Morgan Stanley, one of 18 primary dealers that trade with the Federal Reserve. “Look at the level of yields. If you’ve held a lot of Treasuries, you’ve done well.”

The two-year note yielded 0.51 percent as of 9:11 a.m. in London, after falling to a record 0.48 percent earlier today. The 0.625 percent security due July 2012 traded at 100 7/32, according to data compiled by Bloomberg.

Yields Will Rise

Two-year rates will climb to 0.85 percent by year-end, according to Bloomberg surveys of financial companies. Investors who purchased the securities today would lose 0.4 percent if the projection is correct, according to Bloomberg data.

“Buying now is a big risk,” said Hiroki Shimazu, an economist in Tokyo at Nikko Cordial Securities Inc., a unit of Japan’s third-largest publicly traded bank. “I don’t recommend it.”

Economic growth in the U.S., while weaker than expected, is still strong enough to send yields higher, he said.

U.S. gross domestic product will expand at a 2.55 percent rate in the last six months of 2010, according to the median of 67 estimates in a Bloomberg survey taken July 31 to Aug. 9, down from the 2.8 percent pace projected last month.

Dollar Peg

The People’s Bank of China on June 19 ended its currency’s two-year peg to the dollar, saying it would allow greater “flexibility” in the exchange rate. The yuan has since strengthened 0.5 percent.

The central bank limits the yuan’s appreciation by selling the currency and buying dollars, a policy that has contributed to its accumulation of the world’s largest foreign-exchange reserves and led to the build-up of its Treasury holdings.

China will keep adding to its holdings of foreign debt as long as the nation has a trade surplus, news website Hexun reported, citing Liang Meng, a researcher at the People’s Bank of China. The country recently reduced its holdings of U.S. debt and increased its holding of Japanese bonds due to asset safety concerns, Liang was cited as saying.

The nation also gains foreign currency from trade and invests it in overseas bonds.

China, which has $2.45 trillion in foreign-exchange reserves, is becoming more optimistic on Europe and Japan.

‘Quite a Lot’

The nation has been buying “quite a lot” of European bonds, said
Yu Yongding, a former adviser to the People’s Bank of China who was part of a foreign-policy advisory committee that visited France, Spain and Germany from June 20 to July 2.

Japan’s Ministry of Finance said Aug. 9 that China bought 1.73 trillion yen ($20.3 billion) more Japanese debt than it sold in the first half of 2010, the fastest pace of purchases in at least five years.

“Diversification should be a basic principle,” Yu, president of the China Society of World Economy, said in an interview last week, adding a “top-level Chinese central banker” told him to convey to European policy makers China’s confidence in the region’s economy and currency. “We didn’t sell any European bonds or assets. Instead we bought quite a lot.”

China held 10 percent of the $8.18 trillion in publicly traded U.S. debt as of July. Investors in Japan hold the second- largest position in Treasuries with $803.6 billion of the securities, or 9.8 percent.

China needs a strong U.S. dollar, said Kenneth Lieberthal, a senior fellow specializing in China at the Brookings Institution, a research group on Washington.

“I don’t think we’re going to see any massive flight from China’s holdings of U.S. debt,” Lieberthal said on Bloomberg Television. “That would be self defeating and they well recognize that.”