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Market Recap – More Chatter Around China

October 9, 2015 | Brendan Erne, CFA

Market Digest – Week Ending 10/09

On the heels of a soft US jobs report the prior week, global stocks rallied on Monday, then further extended gains following a more dovish tone in the Fed minutes release. Emerging market stocks performed particularly well, driven by rebounding oil prices and a catch up rally in China as trading resumed following a week-long holiday. Gold ended the week in positive territory, although US bonds fell.

Weekly Returns:

S&P 500: 2,015 (+3.3%)
FTSE All-World ex-US: (+4.8%)
US 10 Year Treasury Yield: 2.10% (+0.11%)
Gold: $1,157 (+1.8%)
USD/EUR: $1.136 (+1.2%)

Major Events:

• Monday – The US, Japan, Canada and other Pacific Rim countries finalized the Trans-Pacific Partnership, one of the largest regional trade accords in history. The deal still needs congressional approval.
• Tuesday – The US trade gap widened to $48.3 billion in August, due mainly to the strong dollar and weaker demand overseas.
• Tuesday – Microsoft unveiled its first laptop ever, designed as an alternative to the firm’s Surface tablet.
• Wednesday – SABMiller rejected Anheuser-Busch InBev’s $99 billion takeover offer, stating the price was too low and undervalued the company.
• Thursday – The US Fed minutes showed a unanimous decision to leave interest rates unchanged at their September meeting, due mainly to low inflation and greater risks to the global economy.
• Friday – The Tunisian National Dialogue Quartet was awarded the 2015 Nobel Peace Prize for its work on building a pluralistic democracy in Tunisia.

Our take:

There’s been a lot of chatter in the media surrounding China and its selling of US Treasuries. For those unaware, China possesses the largest foreign exchange reserves in the world, valued at over $3.5 trillion in September. The lion’s share is held in dollar denominated assets, including over $1.2 trillion in US Treasuries. The fear is that at any time China has the power to dump its Treasuries, which in turn would drive up US interest rates and derail economic growth. This perceived “threat” has actually been in and out of headlines for the better part of a decade.

But the story recently resurfaced following China’s devaluing of the yuan in early August. The event largely caught markets off guard, leading to heavy selling pressure on the currency. To prevent further weakening, the Chinese government intervened by selling Treasuries (from its foreign exchange reserves) and buying yuan. The People’s Bank of China said its reserves fell by over $137 billion in the last two months.

So will China continue unloading US bonds? This is the big question. To be sure, if this was the start of a large scale selling campaign, it would be very bearish for the US economy and stocks (not to mention Treasuries). But there’s little evidence to suggest this is the case. For one, the yuan has already shown signs of stabilization, and the rate of Treasury selling has slowed. Perhaps more importantly, there are myriad reasons the Chinese government would want to avoid this. Dumping Treasuries would drive up rates, while simultaneously pushing down bond prices. This means China would be deliberately reducing the value of Treasuries still on its books, which doesn’t seem very logical. It would also weaken the dollar, making US goods cheaper relative to those from China. As an export economy, this would deal another blow to China’s already slowing growth.

China could certainly pare its Treasury reserves further, but if the selling continues it will likely be at a more measured pace. A full scale dump is a poison pill the nation is unlikely to swallow. Nonetheless, it is a threat worth monitoring moving forward.

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