Daily Management Review

Does China Launches Reverse QE by $ 1 Trillion?


The story of China's phenomenal sales volume of US government bonds is gaining momentum. On Thursday, the information received is almost official confirmation, but the problem is also that such moves have extremely adverse impact on liquidity.

Recall that China sold more than $ 100 billion US bonds in just two weeks in response to the destabilization of the currency market. In addition, the total volume of sold treasury bonds totaled $ 107 billion since the beginning of 2015.

In July, it was reported that about $ 143 billion of US Treasuries for three months were sold through Belgium.

On Thursday, Bloomberg reported, citing unnamed sources, that China really has reduced its ownership in the American papers this month to get dollar bulk.

Operations include direct sales, as well as action through agents in Belgium and Switzerland. At the same time, all this information is not public and will not be published. Another source added that China communicated with the US authorities over the sale of bonds. Precise data on sales are not called.

And there are a lot of interesting things. To begin, the operations were conducted through Belgium. This is the traditional way: the bonds are sold through a depository and clearing center Euroclear, the central office is located in Brussels (Belgium). But China could also sell them directly. In addition, Beijing led discussions with the US authorities, and the agency Bloomberg, which is the unofficial mouthpiece of the Fed, reported a decrease in the share of China, although it could still keep quiet about it, waiting for official data for 2 more months.

Moreover, all this is happening against the background of the sale of US debt is generally disadvantageous to the government and the Fed. The main risk is associated with the continuation of sales of reserves and US government bonds, respectively.

According to Citi’s estimates, reserves fall by 1% of US GDP (approximately $ 178 billion) would lead to an increase in the yield on 10-year US government bonds by 15-35 basis points. Assuming that developing countries, which now own reserves to $ 5.491 trillion, lower them by 10% in just one year, the yield on 10-year US bonds will rise immediately by 108 basis points (1.08%), what is a lot.

According to the latest available data, China controls about $ 1.48 trillion of US government debt. This $ 200 billion is held by Belgium.

The devaluation and sale of debt
After stabilization of the yuan, China began work on the currency market, but not at a fixed rate.

This means that if earlier China reduced the reserve within the framework of the exchange rate policy, then following 11 August, it has already begun to intervene directly in Forex market.

Especially noticeable this interference manifested after 19 August, when published "minute" of the Fed. On the same day the correction started, which is still ongoing. This massive use of foreign exchange reserves is necessary to protect its currency one way or another.

China, in the framework of the devaluation of the yuan, needed to get rid of international reserves.

From an operational point of view, China's international reserves by two-thirds consist of relatively liquid assets. At the end of June 2015, the amount of US Treasury securities on the balance of the PBOC is estimated at $ 1.271 trillion, but Treasury bills and notes are valued at only $ 3.1 billion.

Currency, according to the IMF, is divided as follows: two-thirds - US dollars, one-fifth - the euro and 5% of the British pound and Japanese yen. Given the dynamics of the euro and the yen against the yuan this year, it is possible that China will not limit itself with the sale of dollar-denominated assets.

China's foreign currency reserves are still up 134% of the recommended level. That is about $ 900 billion can be used for foreign exchange intervention without a strong impact on China's external position.

If the current rate of outflow of liquidity will continue, and China will sell for about $ 100 billion of reserves in two weeks, its "stock" will be enough for about 18 weeks of intervention.

Obviously, the further implementation of Treasuries should have an impact on the US economy and monetary policy of the Fed.

Also it is necessary to take into account the devaluation of the yuan, that has led to sweeping changes in the foreign exchange market, which is now for some time will be characterized by high volatility due to changes in carry trade strategies.

The devaluation and changes in lending rates in general can bury the carry trade with the yuan. According to Bank of America Merill Lynch, the size of the market may reach $ 1-1.1 trillion today.

China will have to defend its currency, since the change in carry trade will lead to renewed pressure on the yuan. The general size of China's foreign exchange reserves at the end of July is about $ 3.65 trillion. This volume may be used by the Central Bank, which can also introduce strict control over the currency market.

The intervention of the NSC will cause spillover effects on the market. At the same time, China needs to compensate for the pressure or draining reserves, or to step back in the liberalization of the capital account.

The latter option would be bad news in the efforts to liberalize the markets of Beijing to turn the yuan into a basket of IMF currencies.

It turns out that if the entire market carry trade with the yuan is destroyed, China will have to eliminate the proportionate amount of reserves in order to maintain control over the currency.

But if China eliminates $ 1 trillion of reserves, it means effective compensation 60% QE3.

Thus, taking into account also the effect of the use of reserves in the US government bond rate, China launched reverse quantitative easing just on an epic scale.