China's U.S. bond rebalancing would hold few fears for Fed

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01/10/2018 | 09:34 pm
NEW YORK (Reuters) - Federal Reserve policymakers reacted coolly to a report on Wednesday that China could curb its massive U.S. debt purchases, pointing out that such rebalancing by countries can be healthy and would not likely disrupt the U.S. central bank's plan to trim its own bond portfolio.

Bloomberg News reported that unnamed Chinese officials have recommended slowing or halting purchases of U.S. Treasury bonds, a move that, depending on its size, could snag China's efforts to manage its currency and even spark a market selloff that imperils the strongest run of global economic growth in years.

Ten-year Treasury yields jumped and the dollar slumped after the report.

Such a decision by China, the largest foreign holder of U.S. debt at about $1.2 trillion, could pose a tricky decision for the Fed, which is the top holder with some $2.4 trillion. After years of buying assets to prop up the crisis-hit economy, the central bank began gradually shedding them in October and aims to continue doing so over a few years to reset its policy stance.

"Because of the record levels of global liquidity, I still am a believer that the Fed's plan (of) gradually phasing out the balance sheet ... is likely to be imminently manageable, but we'll have to be vigilant in watching market conditions," Dallas Fed President Robert Kaplan told reporters in Dallas.

Kaplan, a former vice chairman at Goldman Sachs, said that while it was "natural" for countries like China to rebalance their holdings, any adjustment would be somewhat muted by major central banks' record demand Treasuries and by investors and firms seeking risk-free assets.

Even while the Fed chips away at its $4.4-trillion balance sheet, its counterparts in Europe, Japan and China are adding to their holdings. Combined, the four central banks have nearly $20 trillion in assets. The world's foreign-exchange reserves grew by $302 billion in the 12 months ending in October, according to the IMF, adding to so-called liquidity.

"We'll just have to see how those cross-currents shake out," said Kaplan. "It's hard to predict."

His counterpart at the Chicago Fed, Charles Evans, said China has "taken various approaches to" rebalancing its portfolio in the past, adding he had no strong opinion on the news report.

St. Louis Fed President James Bullard characterized Wednesday's selling as "just another day in the markets," adding there was little market reaction when China sold about $1 trillion worth of reserves a few years ago.

"That made me more cautious in interpreting Chinese policy as being overly impactful on U.S. Treasury yields," he told reporters in St. Louis.

RISING RATES

In a nod to solid economic growth and falling unemployment, the Fed raised interest rates three times in 2017 and aims to do the same this year as sweeping U.S. tax cuts are expected to boost the economy yet more. Kaplan said three rate hikes are appropriate in 2018 given there's "a lot of strength in the U.S. economy right now."

Yet if China does shift away from U.S. Treasuries, sparking a sustained drop in the prices of bonds and stocks, the tighter finiancial conditions and worries over a spillover into the real economy could convince Fed officials to slow the hikes.

"If this is the start of something more dramatic, then that might make the Fed question what it's doing," said Paul Ashworth, economist at Capital Economics in Toronto. Yet, he added, "there's no way you can do this without the Chinese economy suffering too."

(Reporting by Jonathan Spicer; Additional reporting by Ann Saphir in Lake Forest, Illinois, Howard Schneider in St. Louis, Lisa Maria Garza in Dallas, and Jason Lange in Washington; Editing by Nick Zieminski)

By Jonathan Spicer

Reuters 2018
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