24 August 2019
Since China wants to keep the renminbi competitive,  it has to intervene in the foreign exchange markets, which will mean buying US dollar-denominated assets. Photo: AFP
Since China wants to keep the renminbi competitive, it has to intervene in the foreign exchange markets, which will mean buying US dollar-denominated assets. Photo: AFP

A Treasury storm in a Chinese teacup

There have been three main stories over the New Year that have affected Chinese equities: suggestions that China no longer favored US Treasuries, the selloff in Chinese government bonds and the improvement in export trends.

Firstly, China is the number one holder of US Treasuries (excluding the Federal Reserve) with US$1.1892 trillion as of October. If China stops buying US Treasuries, the market could suffer … but this might already be old news since there is evidence that China has not been a big buyer of Treasuries for several years now.

From January 2007 through July 2011, Chinese holdings of Treasury notes and bonds rose from US$401 billion to US$1.315 trillion. Since that time, however, Chinese holdings have fallen to US$1.189 trillion and touched as low as US$1.049 trillion in January 2017.

Unless a very serious trade war erupts, China is unlikely to discard its US Treasury holdings. Firstly, the bulk of its imports are priced in dollars. Secondly, the yield on Treasuries is much more attractive than on Japanese JGBs or European sovereign bonds. Lastly, the Chinese will want to keep the renminbi competitive and hence intervention in the foreign exchange markets will mean some dollar asset buying.

Over the past quarter, Chinese government bond yields have sold off. This should be viewed positively by equity investors. The yield curve has shifted upwards, indicating a robust recovery, while the steep yield curve is beneficial to the banks in improving net interest margins and helping to write-off bad debts.

Indeed, the leadership of the equity market has changed with financials rallying year-to-date.

Although the rise in interest rates will inevitably mean some form of monetary tightening, real interest rates for many borrowers was close to negative over the past six months based on the Producer Price Index. Moreover, the central bank still has the option to cut the reserve ratio if it needed to target lending more effectively.

According to the International Monetary Fund, after the global financial crisis, emerging market and developing economies’ contribution to global growth rose to about 80 percent of output growth and 85 percent of consumption growth.

In market exchange-rate terms, emerging market and developing economies accounted for close to 70 percent of global output growth and just over 70 percent of global consumption growth during 2010-15. It should be pointed out that the IMF estimated in October 2017 that the global economy would grow by 3.7 percent (EM 4.9 percent, Advanced 2 percent) in 2018.

All this is good news for Chinese exports. While the focus has been on US-China trade policies, it should be remembered that intra-emerging market trade accounts for one of the largest shares of global trade.

Hence, a recovery in emerging markets is a catalyst for Chinese exports and, alongside a weakening dollar, ought to mean that Chinese economic data for the first half of 2018 will be constructive.

– Contact us at [email protected]


Chief Global Equity Strategist at Jefferies

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