Friday, June 17, 2016

First Treasuries, Now China Is Also Liquidating US Stocks

One year ago, this website was the first to observe that when combined with its offshore Belgium-held holdings, China was first slowly then fast liquidating its Treasury holdings, an observation which led us to correctly predict that China would proceed to devalue its currency, which it did shortly after. Sure enough, shortly thereafter it became common knowledge that the PBOC, owner of the world’s biggest foreign-exchange reserves and largest offshore holder of US Treasuries, had burnt through 20% of its inventory since 2014, dumping about $250 billion of U.S. government debt and using the funds to support the yuan and stem capital outflows.
As it turns out, China wasn't selling only Treasuries. According to a Bloomberg analysis when peeking deeper at the TIC data, while China’s sales of Treasuries have slowed, its holdings of U.S. equities are now showing steep declines as Beijing proceeds to liquidate a substantial portion of its US equities.
This means that in addition to oil exporting nations such as Saudi Arabia, whose liquidation of US stocks we also predicted back in 2014 when we commented on the death of the Petrodollar, the "other" big seller of US equities has been found: China's stash of American stocks sank about $126 billion, or 38%, from the end of July through March, to $201 billion. "That far outpaces selling by investors globally in that span - total foreign ownership fell just 9 percent. Meanwhile, China’s U.S. government-bond stockpile was relatively stable, dropping roughly $26 billion, or just 2%."

While it will come as no surprise that China is desperate to procure US dollars to keep its currency balanced as it intervenes now on a daily basis from prevent the USDCNY from soaring above 6.60 and "punish" those who are selling the Yuan, the observations confirms that China’s central bank remains under pressure to raise dollars and smooth the yuan’s depreciation. Only instead of selling Treasurys it has decided to sell stocks. "The equities reduction reminds investors that while China’s $1.4 trillion trove of Treasuries dwarfs its other foreign assets, it has accumulated enough U.S. stocks to influence global markets."
“Selling some of its equities is a reasonable way of raising the cash needed to finance the big drawdown in reserves,” said Brad Setser, a former deputy assistant secretary for international economic analysis at the Treasury.
There is just one problem: what happens if the capital outflows persist and China runs out of US reserves to sell? Because judging by Vancouver real estate prices, and of course the relentless surge in bitcoin, China's capital outflow is only just beginning... not to mention China's $30 trillion in deposits, which dwarf any potential PBOC firewall.
Bloomberg also notes, that while the amount China unloaded is a sliver of the $23 trillion U.S. equity market, it’s significant when compared with holdings of other big investors. The largest American mutual fund, the Vanguard Total Stock Market Index Fund, oversees about $373 billion.
The Treasury doesn’t break down its data into private and official holdings. Yet China’s capital controls limit the candidates capable of amassing such a hoard of U.S. equities. Also, private Chinese ownership of foreign stocks remained stable in 2015, signaling that the selling originated from an official source, SAFE data on international investments indicate.

Given that China’s private holdings of equities abroad are smaller than the nation’s U.S. holdings as reflected in the Treasury tally, “one can reasonably infer that SAFE, whose reserve assets are not included separately in the net international investment position, holds many of the equities," Setser said.
Why did China switch from selling bonds to stocks? There are various explanations: one is that the IMF warned China to preserve a substantial liquidity buffer above $1 trillion in holdings ahead of what may be even more volatile times. Another is that Jack Lew told China in no uncertain terms to stop selling US paper during the Shanghai Accord. Also, according to Bloomberg, "wwitching to selling stocks allows the PBOC to retain safer, more liquid assets such as Treasuries that it can unload easily in times of turmoil. Two rounds of declines in the yuan in the last 10 months spurred market volatility worldwide and led investors to monitor China’s reserves as a measure of how much of its war chest the country was burning through to combat capital flight."
Dumping equities may prove to be a savvy move, considering that the S&P 500 Index has gone 13 months without a new high on a closing basis. China, which more than doubled its holdings of U.S. stocks during the bull market that began in 2009, wouldn’t be alone among government-affiliated sellers of investments abroad. Sovereign funds from Qatar to the United Arab Emirates and Russia have been liquidating assets since crude began tumbling in 2014.
But a bigger question is what is the message that China is sending to the world by now liquidating stocks over bonds.
"The Chinese, or other people for that matter, are taking the view that sitting in U.S. equities is presumably quite risky, and I’m not surprised they’re shifting," said Fredrik Nerbrand, global head of asset allocation at HSBC Bank Plc in London. “This seems like more of a generation of cash more than anything else, and probably a de-risking of their portfolio.”
The problem for the Fed is what will happen if and when everyone else decided to tag alone with China in continuing the Great Unrotation from stocks to bonds, as the last attempt by the Fed to herd investors out of bonds and into stocks fails.
What will Yellen do then?

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