US banking woes compound China’s need for US Treasury alternatives

South China Morning Post, April 3rd

  • With so much risk flooding the global financial sector, it makes sense for China to look for alternatives to investing in US Treasuries
  • However, questions remain over how to diversify that risk and maximise returns at the same time, given the ubiquity of the US dollar

The world has entered into a new phase of global instability, making it imperative again for investors to batten down the hatches against the spectre of rising risk. The aftermath of the Covid-19 pandemic, the effects of the Ukraine war, the recent inflation spike and now the latest banking crisis are making it that much harder for investors to choose where they should ideally lie on the investment curve to mitigate their risks.

For large sovereign investors such as China, the challenge is made even harder by the fact that its traditional bolt-holes are looking less secure.

The US dollar may be regarded as the go-to safe haven in a troubled world, but with so much specific risk originating in the United States right now, Beijing might be better off looking elsewhere for better protection.

The trouble is that the scope for suitable alternatives is limited. China is already in the process of reducing its risk exposure to US sovereign risk. Its holdings of US Treasury bonds fell to US$859 billion in January, its lowest level since 2009, marking a fall of 17 per cent over the last year alone.

The impact of the US Federal Reserve’s interest rate tightening during the last year and the associated uncertainty in the US Treasury bond market has been an obvious cause for concern, but there are deeper worries now about the risk of wider systemic risk considering the problems evident in global banking sector over the last few weeks. The problems arising from the collapse of Silicon Valley Bank and fears of contagion spreading more widely through financial markets will have not helped matters.

While financial market turmoil seems to have settled down for the time being and fears about further Fed tightening will have eased following better-than-expected US inflation news, recession worries and concerns about a possible US debt default still need to be weighed.

While Beijing has been scaling back China’s holdings of US Treasuries, investments in US agency bonds and other alternatives have risen in the last year. These moves might need to be reversed should economic and political factors take a turn for the worse in the next few months.

The risk of a full-blown US debt default might seem a very remote possibility, but that’s not to say it would never happen or that the Treasury market won’t be prone to a nasty bout of jitters should the row over the US debt ceiling continue.

The non-partisan Congressional Budget Office estimates that the deadline for when the US could no longer pay its bills could come any time between July and September this year, depending on the country’s fiscal outlook.

If the stand-off between the Biden administration and the Republican-controlled US House of Representatives intensifies, there is much at stake with the current borrowing limit set at US$31.4 trillion. The economic fallout from a default of this magnitude would be catastrophic for the world, and it’s no wonder China has concerns about its US dollar-based exposure.

China’s investment needs are vast considering the nation’s stockpile of official exchange reserves worth US$3.1 trillion, combined with the revenue generating power of a nearly US$900 billion trade surplus, a large part of it received in US dollars.

The need to diversify from US dollars into other currencies is understandable, especially if China’s confidence is starting to wane. China’s dilemma is how to diversify that risk and maximise returns at the same time.

China needs a large government bond market to invest in, one with great depth, high liquidity, easy access, good security and low transactions costs. The US Treasury market ticks all those boxes but poses a major challenge if China wants to reduce its dollar dependence in a world where the US dollar still accounts for 58 per cent of the world’s official currency reserves.

Yuan’s elevated trade use all talk. Russia would give right arm for US dollars

The alternatives are limited. The euro accounts for about 21 per cent of the global official reserves market, but it remains overshadowed by geopolitical risks from eastern Europe, fallout from the global banking crisis and low returns.

The Japanese yen accounts for about 6 per cent of the global currency reserves market and offers even lower yield appeal, with yen interest rates still stuck in negative territory.

The best that Beijing can do is gradually reduce its US dollar dependence without rocking the boat too much and diversify its risk as wide as possible in the long term. China needs to insulate itself against US contagion risks, but it could be up against it if market events turn sour again in the short term.

David Brown is the chief executive of New View Economics

Copyright (c) 2023. South China Morning Post Publishers Ltd. All rights reserved.

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10 thoughts on “US banking woes compound China’s need for US Treasury alternatives

  1. Factory Orders headline disappoints while ex-transportation comes in better.

    JOLTS much worse than expected. Good for employment pressures.

    Durables Excluding Defense (MoM) (Feb)
    Act: -0.5% Cons: Prev: -0.5%

    Durables Excluding Transport (MoM) (Feb)
    Act: -0.1% Cons: Prev: 0.7%

    Factory Orders (MoM) (Feb)
    Act: -0.7% Cons: -0.5% Prev: -2.1%

    Factory orders ex transportation (MoM) (Feb)
    Act: -0.3% Cons: -0.8% Prev: 0.8%

    JOLTs Job Openings (Feb)
    Act: 9.931M Cons: 10.400M Prev: 10.563M

    1. PPSI was one of your past picks and I was keeping an eye on it, then broke $3 on friday and I regret not getting in. I was busy with my SOFI position which did eventually hit $6, a few days later than I thought. PPSI has an excellent ER and decent cash reserves, i’d say the $5 range short term is “possible”, 10-20cent scalps could be good too. POLA had a sympathy uptick the same day.

      VRME had a few past spikes but presently low cash reserves, this could pop briefly but I assume offering would happen, currently bouncing off ytd lows. LOV had past upticks, but this company also has losses and quite a bit of debt. I don’t know anyone that pays to join a dating service. Not sure what Zacks is going on, maybe the past upticks, so the companies can put out an offerings?

      BBBY still has a very high short percentage, so I would recommend to keep it on the radar. CYN is holding above $1.

      Odd how companies getting approval for Covid products are upticking like IFRX. Bank stocks are not out of the pickture either, CS, SI, FRC…seems risky but they may uptick eventually.

  2. China’s Yuan Replaces Dollar as Most Traded Currency in Russia

    (Bloomberg) — China’s yuan has replaced the US dollar as the most traded currency in Russia, a year after the invasion of Ukraine led to a slew of Western sanctions against Moscow.

    The yuan surpassed the dollar in monthly trading volume in February for the first time, and the difference became more pronounced in March, according to data compiled by Bloomberg based on daily transaction reports from the Moscow Exchange. Before the invasion, the yuan’s trading volume on the Russian market was negligible.

    The switch comes after additional sanctions this year affected the few banks in Russia that retained the ability to make cross-border transfers in dollars and other currencies of countries branded “unfriendly” by the Kremlin. Raiffeisen Bank International AG, whose Russian branch remains one of the main conduits for international payments in the country, was among lenders that came under elevated pressure from European and US authorities.

    Russia has deepened its ties with China since the Feb. 2022 invasion prompted a break in relations with the West. In March, Chinese President Xi Jinping made Moscow his first visit abroad after his reelection and promised the Kremlin expanded cooperation in the areas of trade, investment, supply chains, mega projects, energy and hi-tech.

    Sweeping sanctions targeting Russia’s financial system have forced the Kremlin and Russian companies to switch their foreign-trade transactions from the dollar and euro to currencies of countries that have declined to join any restrictions.

    The Finance Ministry converted its market operations to the yuan instead of the dollar earlier this year and developed a new structure for the national wealth fund to hold 60% of its assets in yuan. The Bank of Russia regularly calls on companies and citizens to move their assets into the ruble or “friendly” currencies to avoid the risk of having them blocked or frozen.

    Despite all that, the dollar remained the most popular currency on the Russian market until now, only rarely losing out to the yuan in terms of volumes on any given trading day, according to exchange data compiled by Bloomberg.

    Also, although the yuan has been more popular in Russia, China’s capital account controls as well as geopolitical concerns among global investors remain a barrier as Beijing seeks to promote the currency’s usage overseas. Global foreign-exchange reserves allocation in the yuan accounted for about 2.7% of the total amount by end of last year, down from the peak at 2.9% in the first quarter, IMF data showed.

    “Now there are fewer dollars on the market as Russia’s revenues decreased due to the oil-price drop and a decrease in exports,” said Iskander Lutsko, a strategist at ITI London. At the same time, “commodity imports from Russia to China are up by 29%, although exports from China are stagnating.”

    –With assistance from Wenjin Lv.

    (Updates with yuan’s reserve allocation in the eighth paragraph)

    ©2023 Bloomberg L.P.

  3. Swedish Krona Weakness Puts Traders on Intervention Watch

    (Bloomberg) — The Swedish krona’s unrelenting weakness has alerted traders to the risk that the central bank could intervene directly in currency markets for the first time in more than two decades.

    The potential for intervention has come into view following the krona’s recent slump to a 14-year low versus the euro. While the Swedish currency has since recovered some ground, it’s still down around 8% in the past year, not far off levels that could spur intervention, according to strategists at Societe Generale SA and RBC Capital Markets LLC.

    “Markets are on the alert for intervention if the krona falls again,” Societe Generale strategist Kenneth Broux said, describing levels around 11.40-11.50 per euro as “high-risk” territory. “The ammunition is in place to intervene if needed, though first they will try to talk it up,” he added, referring to Sweden’s central bank. The currency was trading at around 11.3 per euro on Monday.

    Krona weakness is a headache for the Riksbank as it battles near-double-digit inflation. It has pledged higher interest rates and sped up asset sales to support the currency. Sweden’s property market meltdown and economic recession could make the bank wary of jacking up rates too sharply from its current policy rate of 3%.

    Riksbank deputy governor Aino Bunge said that while a stronger krona would be beneficial, intervention has so far remained off the table. “We target the inflation rate, and in the current situation, a stronger krona would be positive from that perspective,” she said. “But we haven’t talked about any intervention. Of course it is part of the toolbox but it’s not anything that we have raised.”

    Rare Events

    Currency interventions are rare in advanced economies, and the Riksbank last resorted to one in 2001. But a shift in tone was seen at the bank’s February meeting, when governor Erik Thedeen fired a warning shot to “those who speculate against” the nation’s currency.

    The krona is 15% to 20% undervalued in real terms versus its long-term average, RBC Capital Markets strategist Adam Cole estimates, adding this could justify intervention. But he says the move would be risky, because it could “open a pandora’s box, if they set a target for markets to aim at.”

    Also, intervention may not offer the krona lasting relief, given that the Swedish inflation-adjusted, or real, interest rate — the return which investors receive after stripping out inflation — is at minus 9%, versus minus 3.4% in the euro bloc, according to data compiled by Bloomberg.

    Anders Eklof, a strategist at Swedbank in Stockholm, reckons the krona at 11.50 per euro would make policymakers “really stressed,” but doubts they would intervene, given such action usually needs to be supported with bigger hikes than what are priced in.

    “History shows that you need to follow up with punishing speculators with more negative carry,” said Eklof, predicting inflation to gradually cool as the economy slows and tighter policy starts to bite.

    Any decision to intervene will hinge too on Riksbank reserves, which at end-2022 totaled SEK482.4 billion ($46.5 billion). That might be insufficient, given it equates to a single day of krona turnover, noted Simon Harvey, a strategist at Monex Europe Ltd., citing data from the Bank of International Settlements.

    Meanwhile, cooling bets on further interest-rate hikes in the euro zone, alongside intervention speculation, may have given the krona some breathing space.

    “The chatter is out there and may be giving investors reason to pause if the risk is perceived to be great,” RBC’s Cole said.

    –With assistance from Niclas Rolander.

    ©2023 Bloomberg L.P

  4. Russia’s Oil Flows Surge to New High Despite Planned Output Cut

    (Bloomberg) — Russia’s seaborne crude flows are soaring, with no sign that the Kremlin’s threatened output cut is having any impact on the amount available on the international marketplace.

    The nation’s shipments surged by 1 million barrels a day to a new high of 4.13 million barrels a day in the seven days to March 31, according to tanker-tracking data compiled by Bloomberg. The less-volatile four-week average jumped to the highest since June.

    Russia pledged to lower output by 500,000 barrels a day from last month through June in response to a Group of Seven price cap on the nation’s crude sales. On Sunday, it extended the duration of the cut until the end of the year as part of a wider move by the OPEC+ producer group. There’s no evidence from the export figures that the initial cut has been implemented, raising questions about whether a real reduction will be made in the coming months.

    Maintenance closures at Russia’s own refineries and the diversion to its ports of some crude volumes previously piped to Europe may have undermined the impact of any output reduction.

    Separately, the price cap imposed on Moscow’s overseas crude sales will remain at $60 a barrel, with the mechanism seen as doing its job of keeping Russian crude flowing while hurting the Kremlin’s access to petrodollars. Russia still relies on Western insurers to cover more than half of the tanker fleet that exports its oil, according to data compiled by Bloomberg, suggesting that a large proportion of sales are being made below the cap.


  5. Home prices increase for the first time in eight months: Black Knight

    Declining mortgage rates could have improved affordability for buyers in the housing market in February, but instead spurred a demand that, combined with a persistent lack of inventory across the U.S., put more pressure on home prices.

    According to the Black Knight’s mortgage monitor report, home prices rose 0.16% nationally in February compared to the month prior, marking the first monthly increase after seven months of declines.

    In total, 39 of the 50 largest markets saw home prices increase on an adjusted basis in February. To compare, prices fell in November in 48 of 50 markets.

  6. Unless there’s a change in the dynamics of the global oil market, the $65 low may have been the bottom.

    My concern is that going into the 2024 elections, the Biden regime may decide to release more of the SPR.

    Ironically, what amazes me is that USA, Inc. benefits more from high oil prices than any other industrial nation state. Only nations like Saudi Arabia or other oil producers that rely on oil revenue almost exclusively for government social spending benefit to a greater extent.

    High gas prices here in the states don’t matter much anymore, since the bottom 90% don’t matter much anymore. They don’t make a fuss anyway and their personal economy is collapsing as we speak. Only the top 10% benefit, and that’s all that matters.

    As the economy and society continue their long-term collapse, income generating assets continue to increase in value. Those who have sensible leverage and a portfolio of income generating assets will continue to benefit at the expense of the bottom 90%. Of course, this is a counterintuitive conclusion for most of those worried of economic collapse.

    I haven’t read anything Martin Armstrong has been saying over the past several years, but I assume he would not agree.

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