The Never-Ending US Treasury Selloff

Bonds were in the headlines again on Thursday, when 30-year US yields pushed well above 5% and 10-year yields made a run at a five-handle.

The extension of the selloff at the US long-end came on the heels of the prior session’s gilts-driven weakness. That fizzled in the wake of a solid 20-year sale, and there was plenty on the docket Thursday for bonds to digest. But the fact that Treasurys continue to trade heavy speaks to the notion that the factors which prompted the market to reassess the term premium beginning in late July are still in play.

Suffice to say this is the story that keeps on giving for the financial media. And it’s the selloff that keeps on taking from duration knife-catchers. More and more, strategists and money managers are comfortable adding duration given the demonstrable asymmetry in bonds, but it’s going to be touch and go for a while. I endeavored to make that clear last week, when I suggested that although I am, myself, inclined to catch this falling knife, the fleeting bond rally catalyzed by Fedspeak (which indicated the Committee may skip the last rate hike given the impact of higher long-end yields on financial conditions) and a safe haven bid (tied to events in the Mideast) was likely a false dawn.

There was some discussion Thursday around China’s Treasury holdings, which “officially” fell to the lowest in more than 14 years. “Officially” means the line item for China in the TIC release on Wednesday showed a $16.4 billion decline to $805.4 billion, the least since June of 2009.

To say that paints an incomplete picture would be to woefully understate the case.

Make no mistake: China has every geopolitical incentive to weaponize its US Treasury pile, but there are serious drawbacks to such a strategy. If China is selling US securities on net (i.e., if their holdings are falling inclusive of bonds, notes, bills, agencies and US equities), the simplest explanation is that they’re raising dollars to defend the yuan amid persistent USD strength and concerns around the economy.

Indeed, China net sold the most US securities in four years in August, some $21 billion, with most of that decline attributable to Treasurys and stocks. It’s no coincidence that the yuan dropped to a nine-month low in August. State banks were seen selling dollars that month.

As to the larger discussion around an alleged secular decline in China’s Treasury holdings, you really have to quote Brad Setser. I’m not one to defer (to anyone, on anything), but I’d be remiss not to concede that if you’re not quoting Brad on this, you’re probably not getting it right. Here’s what he had to say about the latest TIC data:

If someone wanted to argue that [Wednesday’s] TIC data release shows a modest reduction in China’s holdings of US Treasury and Agency bonds, I wouldn’t disagree. There was an offsetting rise in China’s holdings of bills and dollar bank deposits, though. China’s reported holdings of Treasurys fell, and there wasn’t an offsetting rise in Belgium. And there was no material change in China’s holdings of Agencies.

The official data suggests the fall exceeded valuation changes. The offsetting change was visible in the short-term holdings data, though — so the evidence suggests maturing Treasurys were rolled into cash. The overall story continues to be one of broad stability in China’s estimated overall holdings of US assets.

That’s the best assessment you’re going to get. I won’t pretend to have a better read. There’s no real secular decline in China’s US debt holdings. Belgium is a China proxy. Beijing has shifted to agencies, and they may sell going forward to stabilize the yuan, or even to put pressure on Washington amid ongoing US efforts to stymie Xi Jinping’s tech ambitions, but for now, there’s scant evidence to suggest a wholesale shift.

Still, my guess would be that some of the upward pressure on US yields over the past two or three months was in fact attributable to foreign official selling. I don’t think Brad’s analysis necessarily refutes that. Plus, the TIC data comes on a two-month delay and September was a rough month for bonds.

In any case, that’s just one possible factor behind the relentless selloff at the US long-end. The others are familiar: Fiscal and governance concerns have prompted a repricing of the term premium as increased supply to fund large deficits now needs to be absorbed by price-sensitive buyers given the absence of the Fed bid and less in the way of participation from other price-agnostic investors including banks, foreign participants and FX reserve managers.

At the same time, the US data continues to hang tough, and it’s no secret why. The Fed on Wednesday released estimates of the household wealth gain from 2019 through 2022. Spoiler alert: It was the largest inflation-adjusted, three-year median net worth increase in data going back more than three decades. The median household net worth increased 37% to $192,900 from per-pandemic levels through the end of last year.

I’ll have more to say on that later, but for our purposes here, it’s sufficient to say that monetary and fiscal stimulus contributed mightily to the resilience of the US consumer, and that’s now manifesting in an economy that refuses to roll over despite the most aggressive rate-hiking campaign in a generation. That, in turn, has prompted investors to reassess the neutral rate, another factor in the Treasury selloff.

None of the questions implicit in everything said above will be answered anytime soon, or not definitively anyway. That helps explain why long-end bonds continue to trade poorly and why volatility remains elevated.