China’s foreign-exchange reserves plunged by a record amount in August by $93.9 billion, according to the PBoC, the biggest-ever monthly drop in dollar terms and the largest in percentage terms since May 2012. The sharp drop highlights the strain endured by the People ‘s Bank of China in order to stabilize its domestic currency. The current acceleration in reserves depletion – they have fallen more than 400 Bln USD yoy - could not be seen as neutral for US Treasuries considering how large is the share of China’s foreign-exchange reserves held in Treasuries – 40% according to our estimates.
The chart above is showing the variation yoy of Chinese Reserves (USD Billions) versus US 10Yrs real rate. Since 2010, pressures on US real yields have always increased after the pace of reserves piling up recovers and vice-versa.
Since start of the year, things have dramatically changed. First, reserves started to shrink compared to the previous year while US 10Y real rates headed north some 50 bp. This rise in US real yield could be attributed to the pricing of Fed rates normalization. Yet, we believe this is only a partial explanation as another factor has also been at work which is China selling dollars through Treasuries. At this stage, what matters is to know to what extent these capital outflows reflect Chinese corporate repaying USD denominated debt. This is a critical issue as this may point toward a coming substantial deterioration in Asian corporate credit conditions.