Until last year, China was America’s largest creditor and might have been expected to play a significant role in funding the stimulus through the purchase of Treasury bonds, increasing Washington’s debt to the communist regime.
As tens of thousands of Americans die due to COVID-19, the disease caused by the new strain of coronavirus, there is growing anger among politicians and the public at China’s initial cover-up of what would explode out of its Hubei province into a world-changing health crisis.
Some critics of China’s handling of the coronavirus outbreak and its alleged opacity in reporting the true number of cases and deaths want to hold Beijing to account by handing it at least part of the gargantuan stimulus bill, clawing back money without leaning entirely on new debt.
Any concerns that China will use this moment to dominate the market for Treasury securities, and therefore wield greater power over America’s currency through an enhanced ability to manipulate the dollar supply, should be short-lived, however.
The Federal Reserve is set to be the biggest source of Treasury demand this year “and we think by a long shot,” Mark Cabana, head of U.S. rates strategy at Bank of America Merrill Lynch, told Newsweek, adding that its purchasing will roughly offset the supply of new coupons.
Back in October, the Fed restarted its quantitative easing program of buying up U.S. government debt to keep the markets awash with cash amid concerns about liquidity, and it will continue its large-scale purchasing for the moment.
Jon Hill, a vice president in the U.S. rates strategy team at BMO Capital Markets, said the Fed is “by far the most important source of demand for U.S. Treasuries, and will indirectly fund the stimulus program.”
“Between March 11 and April 15 alone, the Fed bought $1.3 trillion in Treasuries, more than total Chinese holdings as of February,” Hill told Newsweek. “The Fed’s ongoing QE program will slow from that pace, but they will remain a large buyer of USTs for the foreseeable future; even a taper from $75 billion a day to $50 billion per month is still $600 billion per year.”
Data from the U.S. Treasury shows that China is the second-largest foreign holder of American government debt. The Chinese state owns $1.092 trillion in Treasury securities, as of February, accounting for 15.4 percent of all foreign holdings. First is Japan at $1.268 trillion, which is 17.9 percent.
In June last year, Japan overtook China as the largest foreign holder of U.S. Treasury securities.
“Foreign investors, namely Japan and China, will also be key here, but more in calibrating the relative value of Treasuries versus economic fundamentals,” Hill said.
Not everyone is sure the Fed will continue to dominate the market over the coming months. “I don’t think we can count on that,” Robert Tipp, chief investment strategist and head of global bonds for PGIM Fixed Income, told Newsweek.
Tipp said the Fed has been highly supportive of the markets with its Treasury purchases, and has improved liquidity as well as stabilized the financing of government debt. But, once the economy starts improving again, its role will shrink.
“The Fed will stay active to keep the markets liquid, but over the next six months their ability and need to defend massive Treasury purchases is going to go down as we pass the declining stage for the economy,” Tipp told Newsweek. “We haven’t hit that yet, but the Treasury is going to issue a massive amount of bonds, and then they’re going to have to continuously roll over that debt for the foreseeable future and the Fed is going to be a shrinking part of that equation.”
Beyond the Fed, demand for Treasury securities will come from a variety of buyers. But where in the past China and other emerging markets were significant sources of demand, this time around they tend to be net sellers of U.S. Treasuries.
Cabana said China and other emerging market governments are selling their Treasury holdings to create dollars they can use to buy their own currencies, which are weak.
While currency weakness would in normal times give those markets a competitive trade advantage by making their exports cheaper, global demand has evaporated because of the coronavirus pandemic. Moreover, everyone’s currencies are weaker, limiting any potential trade advantage.
Tipp told Newsweek: “They need to bleed out and sell Treasury holdings in order to create dollars to sell to buy their own currencies to try to stabilize and halt the vicious cycle.”
Another issue highlighted by Cabana is current high demand for U.S. dollar cash to meet dollar-denominated payments, such as on debt, which has led to emerging markets wearing down their Treasury holdings.
Hill said the second most important source of Treasury demand this year, behind the Fed, will be domestic investors. “Over the past few years, we’ve seen domestic investors buying an increasing share of Treasury debt to fund Trump’s tax cuts,” Hill told Newsweek. “This trend will very likely continue.”
Tipp said Treasury demand will come from “a little bit of everybody.”
But he warned that the federal government will face rising premiums on its debt because of its enormous budget deficit and “rising pressure over time for [credit] ratings downgrades” unless there is a “major sea change” on the government’s side.
There will be some foreign buyers looking to Treasuries as a potential option because most of the European and Japanese sovereign debt is being “sopped up” by the central banks there, Tipp said.
He also said domestic retail investors may see Treasuries as attractive relative to cash, and arbitrage traders, those who take advantage of price differences between markets, may also be a source of demand if U.S. government bonds are cheap relative to derivatives.
Treasuries are not really about making money, Cabana said, but storing liquid value. Demand will depend on the economic picture as the pandemic wears on.
“It is really a function of what happens at the macroeconomy. And obviously that’s all about virus containment, things of that nature. It remains highly uncertain,” Cabana said.
