div align=”left”In a week which has seen those long quiescent bond vigilantes wielding their cudgel in the US bond market, it is notable that there has been a distinct change in official Chinese foreign exchange investment policy since last Summer, with a emstrongshift out of US agency debt and long dated bonds to short duration Treasuries and commodities such as copper/strong/em. Additionally, there has been an acceleration of bilateral trade deals with countries like Brazil and Argentina that bypass the dollar. /divdiv align=”left”While strategy remains opaque,emstrong it seems reasonable to infer that the country is now scrambling to reduce its huge exposure to dollar assets/strong/em as the implicit policy over the last 20 years of subsidizing exports to US consumers and recycling the resultant trade surplus back into US financial assets has run out of road. Moreover, as I have been warning repeatedly in relation to the downside risks on bonds, not only is a tidal wave of liquidity likely to fuel inflation but supply is soaring while key official demand is declining as Asian and OPEC trade surpluses slump. /divdiv align=”left”Total Treasury issuance over the last 12 mths was $1.6trn (equivalent to China’s entire holding of US financial assets). In Q1 of 2009 alone, long dated issuance reached $278bn; China only bought $15 billion while foreign central banks bought $85 billion in short-term Treasury bills, including $32 billion from China. Crucially, total central bank demand for longer-term Treasuries has been trending down since August 2008; strongemthe curve steepening so many bulls see as reflecting economic recovery prospects (and the 2/10 year spread reached a record 275 bps yesterday) owes as much to China and others boycotting long duration US bond exposure/em/strong./divdiv align=”left”br /That China has had serious misgivings about recent Fed actions is no secret, but their massive accumulated reserves (about 66% of their total foreign holdings) have left them captive to US policy. The last thing they want right now is to precipitate a crisis of confidence in the dollar by official statements or action, but emstrongBeijing is acutely aware that it will be the biggest loser from manufactured CPI inflation to erode the crushing US debt burden/strong/em. On 27 March I wrote: span style=”font-family:georgia;”em’Near term, a combination of growing private sector savings and Fed manufactured inflation will erode the consumer debt mountain, but probably not fast enough to avert a public debt funding crisis sooner or later in the long period of broad economic stagnation that seems the most likely outlook.’/em /spanAs markets accept the reality that trend US GDP growth is now at best 2% medium-term, sooner is a good bet. China’s portfolio strategy of focusing new investment on the most liquid short-duration paper and exiting its Agency exposure seems to reflect those risks. But might China be about to embark on a more radical step to reduce its dollar exposure?/divdiv align=”left”/divdiv align=”left”emspan style=”font-family:verdana;”Please note that summary a/span/ememspan style=”font-family:verdana;”rticles will no longer be emailed to non-subcribers, but free abridged versions are available at /span/ema href=”http://www.deadcatsbouncing.com/”emspan style=”font-family:verdana;color:#3333ff;”www.deadcatsbouncing.com/span/em/aemspan style=”font-family:verdana;” on RSS feed. Alternatively, take a free two-week trial and join the hundreds of subscribers accessing the full service./span/em/divdiv class=”blogger-post-footer”img width=’1′ height=’1′ src=’//blogger.googleusercontent.com/tracker/1897020887579135393-2168434266624436217?l=deadcatsbouncing.blogspot.com’//divdiv class=”feedflare”
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Last 5 posts by Sean Maher

• Who was Smuggling $134bn in US Bonds into Switzerland? - June 12th, 2009
• Geithner Toxic Asset Plan Collapses: Will US Banks Follow? - June 10th, 2009
• US Unemployment hits 9.4%...that's Bullish, Right? - June 5th, 2009
• Oil Price Surge: Deja Vu? - June 3rd, 2009
• Bond Market Rediscovers Inflation... - May 22nd, 2009