Trade Spat Unlikely to Fuel China’s Treasury Sales

China has started unloading Treasuries, signaling that they could use their $1.2 trillion in U.S. government debt as a potential bargaining chip in trade negotiations.

As shown in the LPL Chart of the Day, China’s Treasury holdings declined to a six-month low in July. China’s Treasury holdings have also dropped for two straight months for the first time since November 2016.

China's U.S. Treasuries Holdings Drop to Six-Month Low

China may use its massive position in U.S. Treasuries to inflict economic pain on the United States by driving up borrowing costs, but we think the probability of significant selling is low. While China’s Treasury holdings have declined, they’ve fallen only about $12 billion, or 1%, over the last two months.

The economic relationship between the U.S. and China is somewhat symbiotic: China extends credit to the U.S. (via Treasury purchases) so the U.S. can purchase goods from China (as its largest trading partner). If China sells enough Treasuries, the impact on the U.S. economy can significantly curb demand for Chinese goods, leading to an inevitable downturn in its own economy. China’s selling could also boost the yuan’s value versus its peers, which could weigh on demand for China’s exports. As shown in the chart, the yuan climbed 6% versus the U.S. dollar in June and July, in tandem with the selling.

“While China sold Treasuries in June and July, we are still not concerned about China using its balance sheet as leverage in trade discussions,” said LPL Chief Investment Strategist John Lynch. “China has a lot to lose economically with this strategy.”

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