China could make it harder for U.S. Treasury Secretary Steven Mnuchin to finance budget deficits brought on by President Donald Trump’s tax cuts.
Chinese officials reviewing the nation’s foreign-exchange holdings have recommended slowing or halting purchases of U.S. Treasuries, Bloomberg News reported Wednesday. While it’s not clear whether the talk would lead to any concrete change, the news added to bond investors’ woes as global debt markets were already selling off amid signs that central banks are starting to step back after years of bond-buying stimulus.
The yield on 10-year Treasuries increased three basis points to 2.58 percent on Wednesday -- its highest level in 10 months.
For U.S. policy makers, there’s an extra layer of caution: The Republican Congress and the Trump administration just approved a bill laden with tax cuts that are estimated to increase federal deficits by about $1 trillion over the next decade.
“Financing a big deficit in the U.S. is going to be tough if China is not involved at all, or even worse, if they start competing with Treasury by selling their own holdings,” said Thomas Simons, a senior economist at Jefferies LLC in New York. He sees tax cuts and the Federal Reserve’s moves to shrink its balance sheet pushing up Treasury’s financing needs by 70 percent in 2018.
China owns almost $1.2 trillion of U.S. government debt, more than double the level from a decade ago. Chinese officials believe the market for U.S. government bonds is becoming less attractive relative to other assets, and trade tensions with the U.S. may provide a reason to slow or stop buying American debt, according to people familiar with the matter.
‘Deeply Invested’
At the same time, though, China is so heavily invested in U.S. public debt that it has an interest in keeping the market healthy, said Nathan Sheets, chief economist for PGIM Fixed Income, who served as Treasury undersecretary for international affairs in the administration of former President Barack Obama.
“If China were to do something that created uncertainties in the government securities markets, China is a major foreign holder of U.S. Treasuries, so it’s deeply invested in that market” and wouldn’t want to make any moves that could hurt its own position, Sheets said.
Sheets said the U.S. has withstood similar tests before over the past 15 years. China and Japan are the two largest holders of U.S. Treasuries and each have ramped up purchases due to currency interventions, only to slow down and cause market jitters. China most recently spurred concern in 2015 when it slowed investments. “That leads me to be pretty relaxed about this,” Sheets said. “There’s lots of demand for Treasuries from the U.S. and abroad.”