For quite a long time I obsessed over November 20, 2013. It was a day that for the vast majority of humanity was like any other, nothing too far out of normal and certainly nothing that would seem to mark it for remembrance. But in my realm of yield curves and interest rate swaps, the things that tell us a little something about the eurodollar’s world, the one we all actually live in, November 20 was an earthquake or a volcanic eruption.
For one, swap spreads collapsed – by a lot. For a single day or two days a move like that wasn’t unheard of, only that big countermoves to trend were usually timed to surprises in Fed announcements. The 30-year swap spread, the difference between the quoted interest rate swap rate from ICE and the same maturity US Treasury yield, had sunk from -9 bps on Monday the 18th to -13 bps Tuesday the 19th and finally all the way to -24 bps that weird Wednesday.
What made it all the more intriguing was that for several months up to that point swap spreads were decompressing in what sure seemed (to convention) like reflation. A negative swap spread is an assault on basic finance, something that wasn’t supposed to be possible (getting paid less on the fixed leg of an interest rate swap than a similar UST suggests on the surface the market believes private largely financial counterparties are less risky than the United States Treasury; that’s nonsense, of course, where instead a negative swap spread only tells us that something is wrong on the inside of the monetary system; i.e., balance sheet capacity to address what should easily fall under covered interest parity). Getting back to a zero 30-year spread for the first time since late 2008 was widely hailed as one of those round number points of significance (that are still serialized today).
It wasn’t just IRS swap prices that registered the rumble, either. The UST curve at the 5s10s which had been moving sharply steeper abruptly reversed (though it would be some time before that reversal was far enough along to be clearly indicated as such). Most people tend to pay attention to the 2s10s and only for the possibility of inversion, but it’s the 5s10s (in between) where everything that really matters gets sorted out – including some very direct relationships with other monetary spaces like interest rate swaps.
In many ways, November 20, 2013, marked the end of Reflation #2. It didn’t immediately produce the next downward leg, of course, but it did hint that something else was going on that might have been serious enough trouble so as to greatly and persistently reduce the chances of reflation following through.
The only real news of note on that day was from, surprise, surprise, China. The central bank, the People’s Bank of China (PBOC), announced out of nowhere that it was no longer in that country’s interest to increase its stockpile of foreign reserves. They had, so they claimed, obtained enough. In the context of late November 2013, that was taken as a warning sign in the conventional “the dollar is finished” sort of geopolitical game common from 2009 forward. The Chinese were threatening the Treasury market, and why wouldn’t they since interest rates had nowhere to go but up!
While that original decree said nothing about actively selling Treasuries, the Chinese would begin to do just that. Starting around April 2014, the figures produced, ironically, by the US Treasury Department (TIC) recorded the start of a truly massive “selling” wave. Between that month and the end of 2016 almost two years later, China (including all its pockets in Belgium as well as in Hong Kong) ended up dumping more than $456 billion in UST assets – almost half a trillion high to low.
According to the rhetoric of the time, and what still passes for conventional wisdom, it was disaster for the UST market and the United States as a whole given that China holds all the financial cards, right?
Of course not. That’s not how all this works. The “rising dollar” that hit China first was for that country far more of a problem than it was for the US or anyone else in the Western developed world (it was still a big setback here, producing a serious economic downturn, just not to the same degree as mostly EM economies like China). The “selling” of UST assets wasn’t a matter of policy, it turned out, but of survival (that’s overstating it, but only by a little).
The Chinese were not alone in their sink or swim “dollar” trials, as countries around the world particularly via their official channels began in late 2014 to dump UST paper in record amounts. It wasn’t a repudiation of the dollar as people still today believe, it was instead the direct fallout from the eurodollar’s drastic squeeze renewed for a third time since 2007. I first used the term “rising dollar” in this fashion in March 2014 to try and set the record straight:
What all this data shows, as opposed to conjecture about the supernatural powers of central banks, is that yuan’s devaluation may be directly tied to dollar shortages. In fact, as I argue here, it is far more plausible that a dollar shortage (showing up as a rising dollar, or depreciating yuan) is forcing the PBOC to allow a wider band in order that Chinese banks can more “aggressively” obtain dollars they desperately need. Worse than that, the PBOC itself cannot meet that need with its own “reserve” actions without further upsetting the entire fragile system.
Though we view and date the “rising dollar” as a 2014 issue, even a late 2014 start, it actually had its roots sunk deep in the summer of 2013. Nowhere was that more the case than China. It has been lost to history, overtaken by greater events during the “rising dollar” period, but Summer 2013 wasn’t a pleasant one on that side of the Pacific (revisit SHIBOR) for all the same reasons we continue to chronicle to this day (what happens in RMB when “dollars” become hard to come by).
How, then, do we view the PBOC’s November 20, 2013, announcement? Over time, I began to see it as more like desperation, the kind of “oh we meant to do that” public statement that is oftentimes crafted only to reassure the public that what turned out to be a big negative was really what they meant to do all along. I have come to believe that by late in that year, Chinese officials knew what was coming (they already had a taste) and were trying to get ahead of the “rising dollar” so that it might not spiral, for expectations, anyway, out of their control (with the media playing right into it, the exact point of my March 2014 article).
After all that happened 2014-16, what did the PBOC do on June 6, 2017? Quite conspicuously they announced that they were ready to resume buying UST’s again (which they had started months before), this time transparently attempting to encourage the eurodollar world that everything was fine and good, the problem fixed in CNY and China. The currency was at that point early on in what would become a rapid ascent trend over this past summer (and detour, importantly, through Hong Kong on HKD’s credit).
You may even detect a pattern linking PBOC announcements about UST’s, the ultimate disposition of those assets (and others), and the contrary direction of the currency.
History isn’t linear, it’s cyclical. In the saga of China’s UST holdings and more so misguided orthodox fears about them I wonder if we haven’t now traveled full circle. Late yesterday, Asian markets were abuzz that senior Chinese government officials have recommended to the various official channels that they slow or even halt their renewed purchases of UST’s. The news was greeted, predictably, in the same fashion it was back in November 2013; big trouble for UST’s and the US economy.
Is that what’s really going on, or are the Chinese in inadvertently trying to tell us something very different?