China cut its holdings of US Treasuries by $66bn in November, reducing its position in the safe-haven debt to the lowest level since 2010 as the country battles to stabilise its currency.
The acceleration in sales — the largest monthly decline since December 2011 — threatens a rise in US interest rates if it continues and follows an unwinding in October that saw China cede its position as the largest foreign holder of US Treasuries to Japan.
China has been selling its foreign exchange holdings in part to support the renminbi, which has fallen 4 per cent against the US dollar since the start of last year. The fall in Treasury holdings is part of a wider campaign by Beijing to stem capital outflows.
The selling is likely to have amplified the volatility in Treasuries after the US election, when yields on the benchmark 10-year notes climbed as high as 2.64 per cent, the highest level since 2014. Investors fear continued selling, coupled with a more hawkish Federal Reserve, could shock yields even higher.
“It’s a big deal,” said John Herrmann, a rates strategist at MUFG. “It is an alarmingly large drawdown and will have to be monitored closely. The question going forward is if we get another bout of selling then the current level of 10-year yields is not appropriate and will have to go higher.”
Mr Herrmann said that further declines, taking China’s holdings below $1tn, would be cause for concern as markets would struggle to digest the selling activity, pushing rates higher. The country’s overall foreign exchange reserves fell by $41bn in December to $3.01tn.
“China wants to be very careful in how they wind down their Treasury holdings,” said Jerry Lucas, a strategist with UBS Wealth Management. “Overall reserves are approaching the $3tn mark [and] they will not want it to go that much further, which is why they are getting much stricter on their capital controls.”
Holdings in Belgium, often scrutinised as a proxy for China ownership, declined by $3bn in November, far less than the near $26bn drop a month prior.
Treasury holdings among primary dealers, responsible for underwriting the US government’s debt, rose markedly in November amid China’s selling. Trading volumes also rose, hitting levels last seen in August 2011, when Standard & Poor’s downgraded the US credit rating.
Bill Gross, the famed “bond king”, warned earlier this month that if yields were to rise above 2.6 per cent then the Treasury market risked moving into a secular bear market.
US Treasury yields marched higher on Wednesday after Janet Yellen, Fed chair, warned of a “nasty surprise” if the central bank holds off raising interest rates for too long.
The benchmark 10-year US Treasury yield, which moves inversely to price, rose 9 basis points to 2.42 per cent, with the sell-off accelerating after Ms Yellen’s comments. She added that she expects the Fed to raise interest rates a few times a year until 2019.
The news helped reverse the path of Treasury yields, which have been sinking in recent weeks, as investor optimism that Donald Trump’s plans for fiscal expansion and tax cuts will bring renewed growth and higher inflation has started to wane. The rise in Treasury yields came alongside strong US inflation data earlier in the day.
“All of a sudden she started speaking and the front end has really started to steepen,” said Mr Herrmann. “We had no idea she was going to be this hawkish. She is normally very cautious and gradual.”
The comments also offered respite for financial stocks which on Tuesday saw their worst trading day since the Brexit vote. The S&P 500 financial sector rose 0.8 per cent on Wednesday, leading the index.