China’s decision to end a strict yuan-dollar peg is getting all the headlines today—even though the likely appreciation of the yuan versus the dollar is in the vicinity of 3% or so in 2010. That’s hardly a game changer.
But the bigger China-U.S. news dates back a few days to June 15: After reducing its holdings of U.S. Treasury debt by 6.5% from November 2009 through February 2010, China reversed policy. In March and April China increased its investment in U.S. government notes and bonds by 2.6% to $900.2 billion.
Most of China’s buying went into the longer-term end of the Treasury market. In the 12 months that ended in April China’s buying of Treasuries with maturities of two years or more jumped by 46%. These purchases at the longer end of maturities reversed a swing that had seen China putting most of its cash (in 2008, for example) into short-term Treasury bills.
Chinese buying has been one factor pushing yields on 10-year Treasuries, the benchmark for many U.S. mortgages, down to just 3.25% on June 21. On May 25, the yield on 10-year Treasuries dropped to 3.06%. According to Freddie Mac, the rate on a 30-year fixed mortgage is now just 4.75%. That’s near the all time low of 4.71% set in December 2009.
The U.S. housing market isn’t in good shape, but it’s frightening to think how bad it would be if mortgage rates weren’t this low.
I don’t think there’s anything especially altruistic about China’s buying.
It’s simply a smart bet on lower U.S. inflation. The core CPI showed barely any inflation in May and the annual rate of core inflation increased at a 0.9% annual rate. With inflation that low and U.S. economic growth apparently slowing there’s just about no chance that the Federal Reserve will start pushing up interest rates anytime soon.
The odds are too, that China will keep buying. In five of the last six years, China’s biggest buys of U.S. Treasuries have come in June.