Massive US Debt Sell-off: Trillions May Flood China

On September 28th, statements made by Federal Reserve Chairman Powell and U.S. Treasury Secretary Yellen during a hearing held by the U.S. Senate Committee on Banking, Housing, and Urban Affairs triggered panic in the U.S. financial market, causing the Dow Jones Industrial Average to plummet by 570 points and the Nasdaq Composite to suffer its largest drop in half a year. The U.S. Treasury market also saw a massive sell-off.

U.S. Treasuries led the global bond market decline, with yields rising towards their highest levels since early 2020. Once known as the anchor of global asset prices, U.S. Treasury assets have now become the most dangerous market globally. Persistent concerns about inflation and serious disagreements over the U.S. government's debt ceiling negotiations have fueled market risk aversion. Investors are shunning U.S. Treasury bills maturing at the end of October and early November, as they are considered at risk of delayed redemption.

Data shows that on September 29th, U.S. Treasuries experienced their fourth consecutive day of significant selling. The sell-off swept through U.S. Treasuries, with the 10-year Treasury yield reaching its highest since mid-June, while inflation expectations rose. The benchmark 10-year Treasury yield climbed to a high of 1.567%, closing up 4.3 basis points at 1.527%. The yields on two-year and five-year U.S. Treasuries reached their highest levels since the first quarter of 2020, with the yield on Treasury bills maturing in mid-October rising even more than other Treasuries.

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During the hearing, Powell, under sharp questioning, admitted for the first time that the shift in inflation is not only "not temporary" but could also be "structural," prompting investors to increase their bets on the Federal Reserve's policy tightening. Powell stated, "Due to ongoing supply chain disruptions, which may even worsen in some cases, inflation will be higher and more persistent than expected. The Federal Reserve will use its available tools when necessary." This statement increased market bets on Federal Reserve rate hikes, indicating a slap in the face for the Fed on the inflation issue.

Subsequently, St. Louis Fed President Bullard told Reuters on September 29th that the Federal Reserve should immediately begin to reduce its $8 trillion balance sheet, warning that the Fed may need more aggressive measures to combat high inflation, including two rate hikes in 2022. Bullard said in an interview that he currently expects the annual inflation rate to remain at 2.8% until 2022, well above the Fed's 2% target and the highest in the latest economic forecasts released by Fed officials last week.

Meanwhile, Senate Republicans are blocking a vote on suspending the debt ceiling, putting the U.S. government shutdown on a countdown clock, ready to trigger a U.S. debt crisis and threaten the U.S. economy and financial markets at any time. U.S. Treasury Secretary Yellen once again warned Congress that the federal government's borrowing capacity is nearing exhaustion, with the confirmed date of reaching the debt ceiling being October 18th. She urged Congress to take action to avoid "serious damage" to the economy.

In another statement, she warned that if Congress fails to approve new funding or appropriations bills, the U.S. government will shut down at the end of September. Subsequently, Federal Reserve Chairman Powell also warned in the hearing that raising the debt ceiling is key to avoiding default, and that it is necessary to raise the debt ceiling. The potential impact of inaction would be severe.

JPMorgan Chase's CEO said they are already preparing for the possibility of a U.S. debt default. The bank said in an interview with Reuters that the largest U.S. bank has begun scenario planning on how a potential U.S. credit default could affect repurchase and money markets, customer contracts, its capital adequacy ratio, and how rating agencies would react.

In response, BlackRock, the world's largest asset manager, said on September 29th that as China's macroeconomic policy may shift towards moderate easing, investors are advised to shift towards increasing holdings of RMB-denominated securities, especially underweight Chinese stocks globally. BlackRock pointed out that Chinese assets have a small share in the index benchmark, and customers' actual allocation is insufficient, with room for several times more.

According to new data cited by Reuters, foreign multinational companies are currently increasing their investment in the Chinese market, establishing thousands of new companies and expanding existing ones. In 2020, against the backdrop of a nearly 40% decline in global foreign direct investment, the scale of foreign investment in the Chinese market expanded by more than 10%, reaching $212 billion. Since 2021, inflows of inbound direct investment have continued to accelerate, reaching $98 billion in the first quarter, almost three times the inflow volume of the first quarter last year.Additional analyses have shown that China's bond market has also become a new haven for the global market, reflecting the good investment appeal of RMB assets globally and highlighting its significance as a trend indicator. UBS has stated that this reflects how the Federal Reserve's low-interest-rate policy could reduce the attractiveness of the currency to yield-seeking investors. According to Goldman Sachs' analysis, the widening interest rate differential between the RMB and the US dollar is accelerating the trend of foreign institutions scooping up and increasing their holdings of RMB bonds. The scramble to position in the RMB asset market is evident, attracting trillions of dollars to continuously flow into China's bond market, which is expected to reach 13 trillion US dollars. The reason for this is that Chinese bonds can offer higher returns and high reliability, which is the core factor attracting foreign capital. Goldman Sachs further stated that among this, 250 billion US dollars might come from global central banks, and the latest data is feeding back this analysis.

Data released by the China Central Depository & Clearing Co., Ltd. (CCDC) in September showed that by the end of August, foreign institutions had increased their holdings of RMB bonds for 33 consecutive months. In August and July, they collectively increased their holdings of interbank bonds by 105.9 billion RMB yuan, more than double the increase in June, setting a new high for the scale of holdings increase in five months. Another new piece of news is that some foreign institutions, including Morgan Stanley and Pictet Asset Management, also believe that the advent of the Beijing Stock Exchange may accelerate the style change of foreign investment in the Chinese market.