At the end of January, foreign countries owned $1.32 trillion worth of U.S. MBS, or 15% of the total outstanding, according to Ginnie Mae. The top owners: Japan, China, Taiwan and Canada.
China had already begun selling off some U.S. MBS last year, with the country’s holdings at the end of September down 8.7% year over year and down 20% by the start of December. Japan, which had shown gains in its MBS in September, showed a drop at the start of December.
If China and Japan were to accelerate those sales further, and if other nations were to follow, mortgage rates would rise even more than they are now.
*The spring housing market is already floundering amid high home prices and weakening consumer confidence. *
To add to the pain, the U.S. Federal Reserve, which is a major owner of MBS, is currently letting the MBS roll off of its own portfolio, as part of an effort to shrink its balance sheet. In other times of financial crisis, like during the pandemic, the Fed was buying MBS to keep rates low.
Back in 1977 Japan bought Pebble Beach. 22 years later Americans bought it back. Similar story with Rockefeller Center. When wannabe empires fade, they give back. Make Am… sorry, not allowed!
Interesting times. Foreign countries also own about $8.6T in treasuries. Japan owned more than $1T in treasuries last time I looked, China about $750B, UK almost that much…
Starting a tariff war with the whole world looked to me looked like starting an economic world war similar to Germany taking on the whole world with a real war in 1939. The economists of the world now know that if they had to, China, Japan, Europe, Mexico and Canada could unload $8.6 T in treasuries and their mbs, and literally bankrupt by far the wealthiest and most powerful country in the world.
I have no crystal ball but the metar lesson for me is real. My overweight cash position is likely to rebalance in favor of international equities instead of USA.
How does it work exactly? I’m trying to think through the process and I can’t quite wrap my head around it. Let’s say China sells $200B of US Treasuries, then they have $200B of cash in the form of US dollars. And someone else has $200B of US Treasuries. Then what exactly is the next step?
Let’s further say that the only buyer was the Fed, so now the Fed has an additional $200B of Treasuries, and China has $200B of US cash in an account somewhere. What exactly is the next step?
If China unloads $200B in U.S. Treasuries, that represents an exogenous demand shock to the bond market. Aggregate demand for U.S. Treasuries (as opposed to other assets) has fallen by $200B. So as bonds are being traded, there’s fewer customers for them - China’s not buying, and some $200B worth of other buyers have already acquired their Treasuries, thank you very much. So the bond market pricing reflects that - prices fall, yields rise, and the next Treasury auction will result in lower priced/higher yield bonds. Which is not what the Administration wants.
“There are 3 ways to win in this industry: be first, be smarter, or cheat”.
I suspect Japan was trying to be first, but still early enough for China to be first-enough. Simply start selling a reasonable stake of Treasuries, because right now there are enough buyers. This will compete with new issues from the Treasury, so China just needs to undercut the auction.
Next step is the big players simply stop buying new issue bonds from us.
I agree that the price of treasury securities might drop somewhat. But I don’t think my question was understood, or maybe I didn’t make it clear enough. There exists $200B somewhere, what exactly happens to that $200B?
Here’s one answer -
So they will sell US treasury bonds and then buy different bonds (and stocks)? That increases demand for those other bonds and decreases demand for treasuries, but the other traders will see treasury yields go up, while other bond yields go down, so they will arbitrage it and the end result is roughly equal to what it was before.
This is not the next step, it is usually the first step. Because it is a lot easier to simply not bid at auction than to decide which bonds to sell. And easiest of all is simply to allow bonds to mature and not reinvest. That’s what the Fed has been doing for many months now.
But none of that is the essence of the question. The question is more macroeconomic in nature. The $200B exists SOMEWHERE, and if it’s in a bank, it’ll probably be invested in various securities, mostly T-bills nowadays. So when someone sells $200B of Treasury securities, and then deposits that money into a bank, it usually gets reinvested into … Treasury securities.
The balance of payments says that the US trade deficit has an offsetting capital surplus, which is what we observe in the data.
If the US runs a trade deficit, which it has for a long time, then the US will have a capital surplus meaning a net flow of foreign investment into US assets, which the US absolutely has.
So, on average, that $200B will find a home in USD assets. Period.
But that $200B will just end up in another USD asset as long as US runs a trade deficit. Alternatively, that $200B could be spent on US goods and services, which would reduce the (US) trade deficit.
The balance of payments applies to USD totaled over all US trading partners.
Any particular dollar could wind up anywhere, but because the US has a trade deficit (when payments are totaled over all trading partners), the US also has a capital surplus.
Thus any US dollar drawn at random from a foreign entity will end up, on average, invested in USD assets. So this is a statement about “an average” foreign held US dollar.
Then what is your rationale for why bond yields increased by over 10% (the 5 yr Treas yield increased by nearly 20%) in such a short period of time if selling bonds and buying other stuff should result in roughly equal to what it was before.
Yes, but that still gets reflected in the bond market. If China reduces their bond holdings and moves their dollars into other assets, the price of bonds will fall and the yield will rise. It’s cold comfort to the bond markets if they move their dollars into another asset class (say, real estate) and prices move up in that asset class - because bond prices will still fall. Which causes pain to the administration.
It’s difficult to say what “cold comfort” means. It’s just shifted from one USD asset to another.
The exact economic effect is: “just depends.”
There is a ton of foreign owned equities for example.
USD could go into corporate bonds.
If China holds a lot of US Treasuries, I’m not sure it’s to their benefit for Treasury prices to decline rapidly as this would reduce the value of their remaining Treasury holdings. I could see them going for a gradual unwind, in the same way they gradually tightened their grip over Hong Kong governance.
But that matters. Although I’ve been referring to “bonds” as shorthand, what we’re specifically talking about is U.S. Treasury bonds. If there is a major, exogenous drop in demand for U.S. Treasuries, the price for those specific assets will drop and the yield will rise.
And that is very scary for the Administration. Most directly, rising yields on U.S. Treasuries impose budgetary pressures on the federal government. But also because a ton of market participants view the Treasury bond market as a proxy for the vitality/desirability of the U.S. economy. Normally, uncertainty in the broader market results in a “flight to safety,” and treasuries become more desirable. If the reverse happens, and treasury prices fall, it scares market participants.
We’ve already seen this play out. The Administration was talking tough about holding the line on global “reciprocal” tariffs, asserting that there would be no delays or suspensions…until yields started rising on treasuries. And that is what prompted the Administration to put a global pause (ex China) on those tariffs - falling prices in the Treasury bond market.
So the ability to dump U.S. Treasuries is another arrow in China’s quiver to push back on the Administration in the ongoing trade war. It doesn’t matter that falling t-bond prices might be accompanied by rising prices in another asset sector - the Administration has already shown itself to be sensitive to movements in treasury prices/yields.
I agree that declining demand for something can result in a lower price for that something.
I also agree that a reduction in the US trade deficit will be associated with a decline in demand for USD assets.
Maybe, but do we have any evidence that this arrow is meaningful and real?
Is there any evidence that China or another government has or would dump Treasuries in a non-gradual way?
(which would lessen the value of that foreign government’s remaining Treasury holdings, of course, and weaken the dollar and hurt China’s exports, which should both be painful by the way if the selling of Treasuries is meaningful - that’s a double ouchy)
Has a large foreign entity shown any evidence that it is willing to take on this level self harm?
If this kind of asset dislocation is meaningful, how do you know that “it doesn’t matter” to some important entity(s)?
Wouldn’t other market participants react to a large re-pricing up or down?
We don’t know. It’s a pretty thermonuclear option, that’s for sure - but we’ve also never been in a world where the world’s largest economy imposed a 100+% tariff on every single product from the world’s largest exporter (before the latest exemptions). Both parties are operating in a position where huge self-harm is on the table.
Prior to the recent steps by the Administration, one would have questioned whether there was any evidence that the U.S. would be willing to take on the level of self harm implicit in launching a massive trade conflict with every country on earth. But here we are.
Doesn’t matter to the Treasury bond market that the other asset class is appreciating. IOW, the rising prices in the other asset class don’t counteract the negative consequences causing by the falling prices in Treasuries. If China were (hypothetically) to sell $200B in treasuries and buy $200B in U.S. stocks, the increase in stock prices wouldn’t offset the consequences of the decrease in bond prices.
Obviously it matters to many people if that happens - but it doesn’t matter to the bond market that the dollars have to land somewhere eventually, in the sense that it doesn’t undo the effects of the bond sales.
