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A trader watches US Federal Reserve chairman Jerome Powell on a screen at the New York Stock Exchange. International investors are following the Fed’s lead and selling off US government debt, suggesting ebbing investor confidence as the US Congress is at an impasse over the debt ceiling. Photo: Reuters
Opinion
Macroscope
by David Brown
Macroscope
by David Brown

Chinese investors are backing off US assets as economic storm clouds gather

  • Investors are taking their cue from the US Federal Reserve as it tries to reduce its holdings of US government debt
  • However, there are no signs investors are rushing to the exits on US assets; they are merely adjusting risk preferences ahead of what is likely to be a difficult few months
David Brown
David Brown
Why you can trust SCMP

It looks like China’s investors are giving US investments a wider berth as the outlook on US financial stability clouds over. It is not exactly a fire sale right now, but investor confidence is ebbing away with China reducing its holdings of US Treasury securities by 17 per cent in 2022 to US$867 billion, its lowest level since 2010.

There is a lot at stake with international investors becoming more cautious about the US outlook, especially the deepening bear market for bonds, the rise in US interest rates and the strong US dollar’s fall. But there could be growing concern about rising credit risks given the sprawling size of the US government bond market, which is fast approaching its permitted US$31.4 trillion debt ceiling.
Unless the US Congress reaches a compromise soon, the US Treasury market risks defaulting by the summer and giving global financial markets a bloody nose in the process. It is something the world can ill-afford after all the shocks in recent years.
It is inconceivable that it could ever come to a US credit default, but the world has been close to the edge before. It could be a close-run thing trying to strike a deal in Congress, especially considering the 15 ballots it recently took to elect Kevin McCarthy as speaker of the US House of Representatives after fractious infighting within the Republican Party.

It doesn’t bode well for US President Joe Biden trying to reach a budget compromise in the next few months, potentially leaving the US Treasury market at dire risk. In the last year alone, 10-year US Treasury yields have more than doubled to 3.86 per cent.

The chances are the market could see yields breach pre-2008 levels above 5 per cent if the going gets rough. If gridlock deepens and investor confidence implodes, don’t rule out the possibility of double-digit US bond yields.

China is not alone among the major economies taking a more defensive stance towards potential US risk exposures. Investors in Japan have scaled back their holdings of US Treasury securities by about 17 per cent in the last year, while France has cut its holdings back by about 15 per cent during the last 12 months.

It is hardly a surprise considering that US Treasury investors are simply taking their cue from the US Federal Reserve as it endeavours to reduce its holdings of US government debt to shrink its bloated balance sheet. If the world’s biggest holder of US government debt is offloading bonds, it probably makes good sense to follow the Fed’s example.
An eagle tops the US Federal Reserve building’s facade in Washington. The US central bank is now shrinking its balance sheet, reversing the quantitative easing process that began after the 2008 financial crisis. Photo: Reuters
The Fed has a long way to go in trimming down. The series of economic shocks which followed the 2008 global financial crisis and led up to the Covid-19 pandemic exploded the Fed’s balance sheet to a peak of nearly US$9 trillion by April 2022 after successive rounds of debt buy-backs under the Fed’s quantitative easing and debt-buy-back programme, which was designed to drive down long-term borrowing costs and kick-start economic recovery.
Now that the Fed is reversing the process under so-called quantitative tightening, it is no surprise bond yields are heading higher. The Fed is withdrawing market support and investors are rotating out of fixed income and into equities, which look like a relatively safer bet right now.

According to the latest US Treasury International Capital data, China’s investors are not only scaling back US Treasury bond holdings but also reducing investments in US stock markets at the same time. China’s investments in US equities dropped by 8.4 per cent in the year to December 2022, perhaps reflecting weaker confidence in the US economy’s scope for better recovery this year.

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It’s not all bad news, though. China’s holdings of US agency bonds jumped by a hefty 25 per cent in the year to December 2022, a reasonable mark of confidence in US sovereign risk.

There are no signs that China’s investors are rushing to the exits on US assets; they are merely adjusting risk preferences ahead of what is likely to be a difficult few months until a compromise is reached on the US debt ceiling. The spectre of a weaker US dollar and the bear market for bonds is one thing, but fears of a major credit event won’t help matters, either.

The irony is that if there is gridlock on the US debt ceiling and global financial stability is threatened, investors tend to turn to the US dollar in times of strife. Can China afford to ignore it?

David Brown is the chief executive of New View Economics

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