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‘Spotlight On The Euro As A Reserve Currency’: Is This The Most Important Takeaway From The ‘Fake’ China Treasury News?

"... the EUR as a reserve currency appears to be an increasingly attractive long-term proposition."

So Wednesday’s big news was obviously the Bloomberg story about China rethinking its strategy with regard to U.S. Treasury purchases.

The BBG piece – which hit just after 5 a.m. in New York – rippled through markets, but by the end of the day, the panic had faded. We wrote extensively about this and if you’re so inclined, you can review the posts here:

China – as they’re inclined to do – attempted to play down the story, saying (and this is a quote) Bloomberg “might have cited wrong sources or [it] may be fake news.”

Right. Or it “may be” that China would rather you just be in the dark about what they may or may not be thinking about doing or it “may be” that they leaked that story in order to send a message to the Trump administration. Of course one thing that would help is if SAFE invested some of that $3 trillion war chest in a computer. That way, U.S. media outlets wouldn’t be forced to literally fax them requests for comment.

Anyway, Treasurys pared losses throughout the session on Wednesday helped by a solid 10Y auction and ultimately, all was well that ended well, in part because it quickly dawned on everyone that even if they were selling, China would have already done it because it would be all kinds of retarded to jawbone the assets on your balance sheet lower if you planned to sell them.

Still, this is a discussion everyone is going to be having for a while, and BofAML is out with their thoughts which are at least worth skimming for the passages about the possibility that China will diversify into more EUR holdings (something which EURUSD quickly tried to price in when the China headline hit early Wednesday morning). Here’s BofAML:

Whilst we suspect that the news reflects operations already conducted by the PBoC, the announcement also corroborates evidence that long-term institutional investors have been underweight EUR for some years. IMF COFER data shows that EUR holdings as % allocated reserves remain below the historic peaks (not accounting for valuation adjustments, and changes to reporting rules). The announcement is timely as it coincides with President Macron’s official visit and an interesting takeaway from the comments is that China officials have cited trade tensions as a factor in their decision. With politics in the Euro Area on a more stable footing, improving macro fundamentals and the end of ECB QE in sight, the EUR as a reserve currency appears to be an increasingly attractive long-term proposition.

Again, that’s worth noting and it seems to corroborate something Bloomberg’s Richard Jones said as soon as EURUSD spiked on Wednesday. Recall this:

The conspiracy theorist in me thinks the timing of this announcement is not accidental, and that the fact that Emmanuel Macron has been in China this week is not a coincidence.


So that’s the important bit from the BofAML note and in case you haven’t heard enough about why this might not be a huge deal for Treasurys, we’ll leave you with some perspective from the bank:

  • Chinese reserve holdings and their investments in US Treasuries are only one potential factor contributing to the overall level of rates. The nearly $700bn reduction in total Chinese reserves since the end of 2013 has not resulted in a meaningful sell-off in US Treasuries or global fixed income (Chart 3).
  • China should continue accumulating USD via FX intervention and trade. Assuming China doesn’t sell USD outright, they may face supply constraints investing USD in mortgages or corporate bonds. This could push them into lower-yielding money markets or the Fed’s foreign RP pool (Chart 4).
  • The timing of the Chinese report suggests international political considerations may be at play. Treasury investors will closely watch incoming TIC data to determine whether or not China actually reduces its holdings in coming months.



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