Since 2008, China has been the largest foreign holder of U.S. government debt.
According to the latest data available, China’s portfolio of U.S. Treasuries totaled $US1.305 trillion at the end of October, just shy of the $US1.315 trillion peak value registered in July 2011.
In recent years, this development has become increasingly salient in the U.S. political arena.
However, China’s position as America’s largest creditor could be eclipsed in 2014, according to George Goncalves, head of fixed income strategy at Nomura.
In his year-ahead outlook, Goncalves advises clients to consider such a “tail risk” scenario.
“As Japan’s [quantitative and qualitative easing] worked its way to foreign bonds with a 1-year lag, Japanese investors could be forced to seek higher yields overseas,” writes Goncalves. “In our opinion, Japan’s foreign bond buying may just enable it overtake China as the top foreign holder of USTs, especially if/when China continues to diversify its holdings away.”
In a speech last month, People’s Bank of China deputy governor Yi Yang declared it “no longer in China’s favour to accumulate foreign-exchange reserves.”
Yi’s comments triggered speculation that China will become less of a source of foreign demand for Treasuries going forward.
“They are probably going to keep their allocations reasonably stable unless there’s a big policy shift, but it means they will possibly be buying less at the margin,” Sacha Tihanyi, a senior currency strategist at Scotiabank, told Bloomberg News.
Japan, on the other hand, is executing on the massive quantitative easing program it began earlier this year. Though smaller in absolute terms than the Federal Reserve’s balance sheet expansion, Japan’s bond-buying efforts are larger in terms relative to the size of its economy. Naturally, the effect of the program has been to suppress yields on Japanese government bonds.
The idea is that Japanese investors, starved for yield they can’t get from JGBs, will turn to U.S. Treasuries, which have become an attractive investment following a 130 basis-point rise in yields this year.
Japan’s portfolio of U.S. Treasuries was valued at $US1.174 trillion at the end of October, so it still has a $US131-billion gap to fill. Nonetheless, it remains a key potential development to watch out for in 2014.