The People’s Bank of China has been buying yuan and selling its dollar assets to support the currency exchange rate. The central bank made the decision since the surprising yuan currency devaluation last month.

China's Yuan Devaluation

The Chinese central bank decided to reduce the yuan’s reference rate against the U.S. dollar by nearly 2% last month. Its action resulted in more than 2% drop in the value of yuan in offshore trading. One yuan is equivalent to 0.16 U.S. dollar as of September 2.

According to Goldman Sachs Group, the investors should not expect China’s sale of billions of dollars of U.S. Treasuries to drive yields higher immediately.

The benchmark Treasury yield increased from 1.9% last month to 2.15% on Wednesday. Goldman Sachs estimated that the yield would reach 2.5% by the end of this year. Its forecast is still below the 3% model of fair value based on macroeconomic fundamentals.

China sold approximately $100 billion of reserve assets

People’s Bank of China sold approximately $100 billion out of its $3.7 trillion reserve assets including Treasuries since the currency regime change happened on August 11, according to the estimate of Societe General SA. China is expected to reveal its latest holdings on September 7.
In a research note to investors on Wednesday, Francesco Garzarelli, co-head of macro and markets research at Goldman Sachs in London said, the impact of China’s selling is not “straightforward.”

He explained that the changes in the global economic outlook normally undermine money outflows in determining the direction of bond yields. China’s sale of Treasuries is partly offset by investors who are investing cash in fixed income assets given China’s slowing economic growth and global market volatility.

“We would advise against following a narrow flow-of-funds approach. Shifts in macro expectations tend to win the day,” said Garzarelli.

Reserves decline by central banks will hurt dollar-dominated bonds

Garzarelli also stated that the reduction of reserves by China and other central banks, which collectively hold assets worth $11.4 trillion, could hurt dollar-denominated bonds over the long-term. He emphasized that private investors would eventually shift their investments out of debt into riskier assets.

China is the biggest holder of Treasuries worth $1.27 trillion as of June. Approximately two-thirds of the country’s holdings are in dollars.

China will end yuan support this year

Separately Rabobank Group suggested that China’s central bank would end yuan support this year (early in December) and let the currency drop given the existing pressure on foreign exchange reserves.

Michael Every, head of financial markets research at Rabobank said, China needs to maintain at least $2.7 trillion in reserves to prevent any potential shortfalls since the country needs $1 trillion to pay for six months of imported goods and $1.7 trillion for external debt.