Investors are failing to factor in the very real risk of China scaling back on its U.S. government debt holdings, economist Stephen Roach told CNBC.
"Everyone thinks interest rates are going to stay low in the U.S. because the Fed is in the control room... but the Chinese own about 11 percent of the Treasury market right now, and as they start to reduce their purchases of dollar-based assets... [this] will mean higher interest rates," he told CNBC Asia's Squawk Box.
The political crisis in Washington that saw a 16-day partial U.S. government shutdown damaged the perception of the U.S. government's credibility abroad, analysts say, prompting fears that China may reassess its investment in U.S. Treasurys.
China is the world's largest overseas holder of U.S. government debt; any move to sell out of the asset class could prompt a spike in Treasury yields, and therefore benchmark interest rates. Data from the U.S. Treasury department this week showed that China reduced its holdings in U.S. Treasurys to $1.268 trillion in August, down by $11.2 billion from July.
According to Roach, as China starts to reduce its savings surplus and accumulate foreign reserves at a slower pace, its demand for dollar-based assets, like Treasurys, will decline.
"China is on the move with a different [economic] model and there are enormous consequences for its purchases of Treasurys and other dollar-based assets as a result. America has got to face up to that," he said.