China unlikely to wield U.S. bond weapon as tensions stay high

NEW YORK, April 1 (Reuters) – China is unlikely to pare its purchases of U.S. Treasuries significantly anytime soon as its foreign exchange reserves grow, even as trade and geopolitical tensions between Washington and Beijing remain high, analysts and investors said.

The risk that China could slow its bond buying or sell from its more than $1 trillion portfolio is a subject of concern to investors as the two largest economies battle over trade tariffs, geopolitical tensions and human rights issues.

U.S. President Joe Biden last week compared Chinese President Xi Jinping to Russian President Vladimir Putin, calling them both supporters of autocracy. But he said Washington was not looking for confrontation with China over differences on trade, Beijing’s rollback of democracy in Hong Kong, treatment of minority Uighurs and military buildup.

Concerns about relations come as Treasury yields jumped to one-year highs in March and new debt supply to finance government spending and a widening deficit surges to record highs, showing no signs of slowing.

But analysts say it would be complicated for China to unload its bonds without hurting their value and creating losses for itself.

“Despite everything we’ve seen in terms of the increase in tensions, we still haven’t seen China rapidly divest. It’s not a weapon they can use without hurting themselves,” said Matt Gertken, geopolitical strategist at BCA Research.

If an issue like Hong Kong or Taiwan blows up, then China “may use Treasury securities as a signal,” Gertken said. In that case, however, other countries may buy Treasuries on concerns about global stability, which could boost demand for bonds as a safe haven, limiting the impact, he added.

China’s foreign exchange reserves have grown in the last few months as the yuan has appreciated, and that has increased its investments in U.S. Treasuries, Morgan Stanley analyst Min Dai said in a recent report.

China has seen a strong rebound in exports in recent months as it recovered from COVID-19 business shutdowns and imports of Chinese products in the European Union and the United States grew, thanks to fiscal stimulus measures.

The most recent government data showed China increased its holdings of U.S. Treasuries to $1.095 trillion in January, up from $1.054 trillion in October, though they remain below a peak of $1.32 trillion reached in 2013.

Japan is the largest foreign holder of U.S. debt, with $1.28 trillion in Treasuries in January. The Federal Reserve holds $4.92 trillion in Treasuries as of last week.

China’s holdings are also shrinking on a percentage basis as the U.S. government debt supply expands and the Federal Reserve increasingly asserts itself as the main player in the market.

“It’s definitely something I think we have to be aware of but I’m not sure it’s as material as it used to be just given how large the debt stock is of the U.S.,” said Brian Kloss, a fixed income portfolio manager at Brandywine Global.

Outstanding U.S. debt has surged to $21.65 trillion as of year-end, from $17.19 trillion a year earlier and $8.29 trillion in 2010.

Another issue that would make it difficult for China to reduce its U.S. bond purchases is that few other markets are as liquid or low-risk as U.S. Treasuries.

If it does sell bonds, any rise in yields could prove attractive to other investors as the bonds become relatively more attractive.

“As rates have backed up, it starts to become attractive to other foreign investors especially on a hedged basis, so they may step in to fill some of that void if China does back away,” said Kloss.

The Fed is also expected to step in if bond yields rise to a point where they could harm U.S. economic growth.

Either way, “it’s just not a weapon China can use easily,” said Gertken. “China only owns about 5% of Treasuries, so they can move the needle but not much more than that.”

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