Dollar Drops on Reports China to Limit US Bond Holdings

Last year, the dollar posted its worst annual performance in 8 years, driven primarily by geopolitical concerns. Early Monday, a new front emerged that could weaken the dollar, taking markets by surprise. Media reports suggested that Chinese officials were telling banks to pare back their exposure to US Treasuries, citing market volatility and uncertainty.

The revelation wasn’t surprising in content so much as in timing. It’s long been suspected that China would limit its investment in US debt amid trade tensions between the two countries. However, such a policy has never been official. It has long been assumed that China might use the sale of US Treasury securities as a pressure tactic against Washington and would therefore likely do so in the context of tensions between the new countries. But, there seems to have been no news to provoke this disclosure, and some analysts were left scratching their heads about what’s really going on.

China Was Already Reducing Its US Debt Holdings

There was no official announcement, but media outlets reported that Chinese officials were “urging” banks hold back on acquiring US government bonds due to concerns over market volatility. Some institutions would be expected to reduce their holdings. However, it was also clarified that the recommendation did not cover state holdings, such as the PBOC, which holds the largest amount of US Treasuries.

The dollar dipped in response, while long-term US yields rose marginally. This has long been a concern that China could initiate a large-scale sell-off of US debt, which would spike yields and disrupt capital markets. However, Chinese officials didn’t give any specific targets or timing, which apparently reassured traders that this was part of the overall, years-long shift towards de-dollarization.

Who’s Buying Dollars?

Chinese holdings of US Treasury securities peaked at around $1.3 trillion in 2014 and have been declining ever since. They were last reported at $682.6 billion, the lowest level since 2008. China is the third-largest holder of US debt after Japan and the UK. However, analysts note that China is using custodial accounts in other countries, such as Belgium, and that, taking those into account, overall holdings have remained relatively stable. China is apparently rolling funds from its own accounts into custodial holdings, which give it better access to global capital.

While China’s debt holdings fell last year, Norway, Canada, and Saudi Arabia increased theirs by larger amounts, so total overseas holdings of US government bonds rose to the highest level on record. Analysts have argued that it’s not a situation of de-dollarization, but of diversification. The measures being taken by officials in China might be to tighten bank exposure rules rather than actually push to sell dollars.

Will the Dollar Rise or Fall?

Policy uncertainty in the US has left the dollar weaker. Two weeks ago, it appeared that US President Donald Trump expressed approval for a weaker dollar. The greenback tanked, and since then, US officials have repeatedly stressed that they support a strong dollar, which has brought the currency back up.

Initially, the market seemed to believe that the appointment of Keven Warsh to succeed Jerome Powell as Fed Chair signaled the White House’s commitment to a stronger dollar. But confidence in this assessment has been fading again, allowing the greenback to weaken, with the latest China news supporting the move. Now we’ll see if the data later this week causes the dollar to bounce back.

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