Yuan Depreciation Spiral Good for Treasuries

ZeroHedge lays out the "Chinese reserve depletion is bad for the U.S., QE4 is inevitable" argument.

ZH: Why QE4 Is Inevitable
In short, stabilizing the currency in the wake of the August 11 devaluation has precipitated the liquidation of more than $100 billion in USTs in the space of just two weeks, doubling the total sold during the first half of the year.

In the end, the estimated size of the RMB carry trade could mean that before it’s all over, China will liquidate as much as $1 trillion in US paper, which, as we noted on Thursday evening, would effectively negate 60% of QE3 and put somewhere in the neighborhood of 200bps worth of upward pressure on 10Y yields.
Right here is my main beef with the argument. This line of thought assumes China will sell U.S. treasuries into a weak market, that there will be a mismatch of buyers and sellers, in this case way more selling by China and EM central banks.

An alternative model is as follows. Chinese (and other EM citizens) want to hold U.S. dollars and will exchange RMB for USD. This RMB is dumped back onto the market, resulting in more exchanges for USD. A depreciating spiral.

From the currency side, it's easy to see the U.S. dollar rally.

The treasury side is a matter of what to do with those U.S. dollars? Where are greenbacks going to flow in the middle of an emerging market currency crisis?

On the other side of the crisis, things look ugly for treasuries and the U.S. dollar, but both are very likely to peak at the most panicked phase of the crisis.

No comments:

Post a Comment