U.S. Debt: Punchbowl Economics

U.S. Treasuries focused on Fed policy more than prospects for growth; EM currencies rose post-Q2; China trimmed its holdings of U.S. Treasuries along with the rest of its FX reserves.

The quick fall and snap-back of U.S. Treasury yields along with the equity market selloff, highlighted a feature of current market expectations: focusing on the punchbowl rather than the party.

The Fed has been clear about its optimism on the U.S. economy, and has the data to support its beliefs.

That stands out in comparison to other central banks, both big and small; many emerging-market (EM) banks tightened in response to their own economic crises, and the ECB and Bank of Japan continue to support their still fragile economies. A positive scenario for these approaches would be that U.S. growth supports economic strength elsewhere, despite the growing challenges to global trade.

Instead, as the FOMC continues to walk back on easy-money policies, sensitivities have become heightened. In the equity markets, one effect was that the rapid rise of 10-year and 30-year bond yields fed fear of a future spike in inflation rather than a harbinger of low-inflation growth.

On the Rise: BRATs

Since the end of Q2 2018, three of the most troublesome EM currencies have been on the upswing: the Argentine peso, the Brazilian real and the Turkish lira rose 15.0%, 8.8% and 6.8%, respectively. The Russian ruble has risen fractionally, up 0.3%. While it’s true that the dollar rose some 2% against a trade-weighted basket of currencies during the same period, the upward moves are nonetheless significant.

The Argentine peso is particularly notable, since it has clawed its way back from a low of 41.5 against the greenback during trading on September 28 to 35.9 at the close on October 16, without apparent intervention by the central bank – a small but significant victory for the IMF’s rescue plan, at least so far. The small change in the ruble since the end of last quarter masks its 11.8% fall year to date vs. the dollar, but the rise in the price of Brent crude oil from $66.40 to $81.60 constitutes a windfall of some 22.9% in dollars, substantially softening the blow of any current and future dollar-denominated sanctions.

On the Slide: China’s Treasury Holdings

As of September 30, China’s reported foreign exchange (FX) reserves total some $3.09 trillion in all currencies – down some 1.7% since the end of 2017. Also, as of that date, China’s holdings of U.S. Treasuries came to somewhat over $1.16 trillion – also down some 1.67% since year’s end. That suggests that whatever the drawdown of FX reserves might entail, there’s been no trace of preferential selling. It could be informative to see what changes, if any, take place to either asset as the rest of the year unfolds..

In the meantime, the People’s Bank of China (PBoC) has been focusing on domestic policy actions rather than external factors to support growth. Those include loosening monetary conditions by reducing the required reserve ratio (RRR) of banks both large and small for the fourth time this year and sticking with its announced policy toward its own currency, in which its price is determined by market-based shifts in a basket of other currencies.