Official data indicate China has steadily sold U.S. Treasurys this year, with the main question now being the pace of sales as the Federal Reserve gets set to hike its benchmark interest rate.
Expectations of a Fed rate hike in December, plus the uncertainty caused by the from the surprise U.S. presidential election win by Donald Trump, has put pressure on the yuan.
The offshore yuan rate touched a record low of 6.9441 against the dollar on Wednesday, Reuters reported, on a day that saw heavy U.S.-based selling of Treasurys as minutes from the U.S. central bank marked a clear road to a December rate hike. Reports said that traders had speculated Chinese entities were behind the selling of Treasurys futures in order to support the yuan.
The expected rate hike has already seen the dollar gain strength, with the dollar index, which measures the greenback against a basket of currencies, soaring this week. The dollar index last closed at 101.67 on Wednesday, the highest level since January 2003.
On Thursday the People's Bank of China (PBOC) set the yuan midpoint against the dollar at 6.9085, the weakest since June 10, 2008. China launched a managed float of its currency in July 2005 and since March 2014 has allowed the yuan to move within a 2 percent band around the daily fix.
A stronger greenback puts exchange-rate pressure on emerging market companies and governments that need to make dollar-denominated debt payments. U.S. Treasurys are widely bought by such entities as a way to hold dollars because the sovereign guarantee and highly liquid trade make it a safe and easy way to redeem for the cash needed to make payments.
By selling Treasurys, meanwhile, China can use the proceeds to buy yuan and support the exchange rate in the market.
Capital Economics Senior Markets Economist David Rees said in a note to clients early Thursday that a key aspect to watch was whether the PBOC felt forced into aggressive action to protect the yuan.
Data from the U.S. Treasury department show that China, which is the largest buyer of U.S. government notes, has cut its holdings every month between May and September this year. In May, China held $1.24 trillion worth of Treasury bills, trimming it by $87 billion to $1.16 trillion by September. Data on foreign holdings of Treasurys for October is due on Dec. 15.
"Admittedly, China holds the majority of foreign exchange reserves in the emerging world, and the People's Bank has been running down its reserves for some time to support the renminbi (yuan). This intervention could well increase if sentiment towards the currency continues to sour and capital outflows accelerate," Rees said.
China's major state-owned banks have several avenues to trade in the U.S. Treasurys market, including futures, and can act as proxies for the central bank, depending on market conditions. Much of the focus now is on foreign exchange reserve levels in China, with reserves down $45.7 billion in October, according to figures published this month, marking the sharpest decline since January, to $3.1207 trillion, the lowest level since March 2011.
During his campaign, Trump took China to task for what he said were unfair trade prospects, including manipulating the yuan lower to favor the country's exports.
Zhang Xiangchen, China's deputy international trade representative, said in Washington D.C. on Wednesday that the country would rely on World Trade Organization tariff rules on market access if Trump made good on threats to levy punitive duties on goods made in China, Reuters reported.
"I think after Mr. Trump takes office, he will be reminded that the United States should honor its obligations as a member of the World Trade Organization," Zhang said through an interpreter, Reuters reported. "And as a member of the WTO, China also has the right to ensure its rights as a WTO member."