China’s recent selling of US Treasuries suggests it may support structural dollar weakening, but the country’s diversification into alternative dollar assets indicates a more complex dynamic at play, analysts say.
US Treasury International Capital (TIC) data this week shows that China’s holdings of US Treasury securities declined for the fifth straight month in March, falling to $1.145 trillion dollars, compared with a high of $1.175 trillion in October.
While it’s tempting to interpret the move as a managed approach to dollar decline, it would be mistake to do so, says Geoffrey Yu, currency strategist at UBS in London.
“China may be moving out of Treasuries but that doesn’t mean it is moving out of the dollar,” says Yu. “We are seeing a steady process of diversification into other dollar-denominated assets, which should provide substantial dollar support.”
Paul Mackel, senior currency strategist at HSBC says: “There is continued downward pressure on the dollar but Asian central banks are going to continue to buy. They may buy corporate bonds or agencies rather than Treasuries, but I would not read the TIC data as a move away from the dollar.”
While the TIC data showed a decline in Chinese holdings of Treasuries, the net change was a small proportion of the total, Mackel says.
Recent experience shows China’s willingness to sell Treasuries is largely restricted to the short end of the yield curve, with reserve holdings of short-dated debt falling to the lowest level since 2003 by mid-June 2010, according to US Treasury data.
A large proportion of cash proceeds were likely invested in dollar-denominated assets through asset managers and off-shore investment entities on behalf of China’s official reserve manager SAFE, UBS’s Yu says. SAFE has made no secret of its desire to transition to a sovereign fund model, he adds.
Some observers suggest SAFE’s policy of diversification may have been motivated by concern over its relationship with China’s sovereign wealth fund CIC, where officials have announced their intention to look for new sources of cash, leading to speculation it may tap SAFE.
“The politics of the situation are that SAFE does not wish to become an easy funding source for CIC, and in that context its policy of diversifying out of liquid US Treasuries also makes a lot of sense,” says a source.
Yu points out that the dollar remains the world’s dominant investment and settlement currency, and demand from reserve managers, particularly in Asia, is unlikely to change anytime soon.
Recent IMF data suggests dollar reserve holdings increased in 2010 by nearly $312 billion, while the euro’s share of reserves fell to 26.4% from 38.4% in 2009.
| TIC Survey – China’s holdings of Treasurys |
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| Source: US Treasury Dept |