China has a massive hoard of US Treasury bonds worth over $1.2 tn. Many have speculated that as part of a trade war with the US, Beijing may flood the market with these bonds in an effort to enforce pain on the US economy. Recent market data shows it is likely already happening. China recently dumped $20 bn of Treasuries, a move that cannot be accounted for as part of normal market flows. The move was China’s largest sale in more than two years. The sale came in March, just before US-China trade tensions were again heating up.
FINSUM: Our view is that China is more likely to threaten doing this and perhaps do some in small chunks than actually pull the trigger. However, even if they do, yields have fallen so far recently that it is hard to imagine they would rise much beyond where they were a few months ago.
The trade war is very scary for everybody. From politicians to executives to investors (in both nations), everyone is afraid of the implications of the trade war. However, there are some good reasons not to be. Firstly, while there are fears of a market tailspin, the reality is that the dovish Fed should provide a safety net. Secondly, many worry the trade war could bring the economy to a standstill, but remember that only 2.4% of US economic output is at risk of Chinese tariffs. Finally, many fear China could dump its $1.1 tn of Treasuries. The truth is that doing so is very unlikely, and even if they do, it is a small portion of the $22 tn market.
FINSUM: The general theme to take away here is that China is not as big a part of the US economy and markets as many seem to assume it is. That said, the secondary effects of a trade war, such as the psychological impact on business and the effect on the rest of the world, could be considerable.
In a great example of how Trump’s new tariffs on China will reverberate around the US economy, Nike and Adidas are panicking over the new Trump moves. The pair just led a consortium of 173 companies who penned an open letter to the President imploring him to stop the tariff move immediately. Nike and Adidas say the tariffs will be “catastrophic”. Clothing and footwear already endure some of the highest tariffs, so hiking them further will increase costs and create huge logistical complications. The letter summarized their view this way, saying they will be ”catastrophic for our customers, our companies, and the American economy as a whole”.
FINSUM: If you are a company that makes or imports a lot of your merchandise from China, this is going to be a very rough period. We expect the market will start to take this into account as the full impact of the trade war is digested.
There was a beautiful four-month window between December 2018 and May 2019 when everything looked positive. The trade spat with China looked increasingly mild and economic data was strong. It was a mirage. Even the hefty 3.2% GDP growth figure was mostly because of an incredible buildup in inventories, which when stripped away leave growth at 1.5%. Further, revised data shows that industrial production has dropped 1.2% since December. Even though this counts for a small portion of the economy, it is highly indicative of the business cycle. Some areas like auto production and machinery are down much more at 5%.
FINSUM: The glorious rally of the first third of the year seems to have stalled and the bad news is piling up, with the trade war exacerbating everything.
China is beginning its retaliation against the US’ increasing intense trade policy. The country is unloading its holdings of US Treasuries at the fastest pace in two years alongside the big rupture with Washington over trade. Its US Treasury bond holdings are one of China’s arsenal of weapons to retaliate against the US’ tariff hikes. According to Deutsche Bank’s chief economist, “The sheer size of [China’s] reserves and that this is even becoming a conversation means the market should take it seriously”. The country owns $1.12 tn worth of Treasuries.
FINSUM: This is quite a risk for the US as someone would have to absorb all those sold assets, and if they flooded the market, it would cause major volatility and sharp yield rises.