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.
jdtweddale,
We are talking about one of the factors it will take before Bernanke raises the Fed rates. We are painfully aware our current unemployment rate is about 10%, and will remain there for the foreseeable future, unless we need a LOT more Census workers…
arihalli,
Actually, you aren’t far from the true scenario. Picture this: What happens when the supply in the bond markets exceeds the demand? Then the interest rates on bonds have to go up to remain attractive. What the Federal Reserve makes their prime rate is irrelevant to this economic fact. If the U.S. keeps selling these bonds, eventually they will run low on buyers, and the national debt will suddenly get more expensive to maintain.
Keep in mind that U.S. bonds have to compete in the world markets with other bonds. While ours may be considered “safer”, being the best house in a bad neighborhood won’t sell forever.
Ed, It makes sense, as you say, that Mr. Bernauke will keep rates low – but is he the only determiner of low rates? Won’t the bond purchases – when debt begins to scratch the ceiling – DEMAND higher rates? I want to say that i think that WHEN the Fed loses control of the interest rates – that is when financial tsunami probably begins – a swoon that will make the Greek crisis small potatoes and that should eradicate the balance of our middle class. I don’t know if this is correct – but it sounds good!
where you guys comming up with this 7% unemployment. Lets look at the real unemployment rate at least 10% or higher depending on what the government wants you tyo think!! Look at the real numbers!!
No inflation means no activity in the economy, and that kind of sort of means a stock market that is at a top….
yes ?
I guess we can look foreward to a federal government holding the economy down to hold down inflation, and the Federal governemnt then being the primary spender, and China being the primary supplier of money.
Der Staten Ober allis.
Considering it will be a long time before unemployment hits 7%, we can feel comfortable that “Helicoptor Ben” will keep the rates low…
From Krugman:
“Currently, the Fed can’t [increase the interest rates], because the interest rates it can control are near zero, and can’t go any lower. Eventually, however, as unemployment falls — probably when it goes below 7 percent or less — the Fed will want to raise rates to head off possible inflation. At that point we can make a deal: the government starts cutting back, and the Fed holds off on rate hikes so that these cutbacks don’t tip the economy back into a slump.”
If the Congress heeds Krugman’s advice the Chinese will benefit too 🙂 A deflated, depressed America economy is not good for anybody.
http://www.nytimes.com/2010/06/21/opinion/21krugman.html?partner=rssnyt&emc=rss