Treasury holdings 'reflect economic shifts'

Japan resumes place as largest US creditor, but China likely to favor dollar assets again

Japan has overtaken China as the largest foreign creditor of the United States, a development that reflects economic and policy changes in the world's three largest economies, experts said.

According to data from the US Treasury, private investors and official institutions in Japan held $1.2244 trillion in US government securities as of the end of February, narrowly exceeding the $1.2237 trillion held by China.

The figures mean that Japan has regained its ranking as the largest holder of US government securities, a status that it lost to China six years earlier. But with just a $700 million gap in their holdings, things could easily change in the coming months.

Observers noted that both China and Japan cut their holdings in February, the only difference being that Japan cut less ($14.2 billion) than China ($15.4 billion).

Analysts also doubted whether China's holdings are really smaller than those of Japan, because China may have parked considerable assets in places such as the United Kingdom and Belgium, out of concern that its assets could be frozen by the US in a crisis.

Still, the changes signal the shift in the economic landscape in the three economies since 2008, when the global financial crisis erupted and China overtook Japan as the top creditor of the US.

With the US economy recovering, most observers expect that the Federal Reserve Board will raise interest rates later this year. That view is drawing global capital back into the US, keeping Treasury yields low.

Meanwhile, in Japan, the central bank has embarked on record monetary easing to end years of deflation. The financial system is flooded with liquidity and the result is a weaker yen and interest rates close to zero.

The 10-year Japanese government bond yielded 0.322 percent on Wednesday, compared with 1.9 percent on the comparable Treasury note. The gap obviously makes US securities more appealing.

In China, the reduction in holdings of US securities mostly reflects the central bank's operations in the foreign exchange market. As China's economic growth has weakened, so has the yuan, especially since November.

To stabilize the yuan's value, the People's Bank of China might have sold dollar-denominated assets in its open market operations, said Wang Youxin, a researcher at Bank of China Ltd's Institute of International Finance.

US government data showed China has been cutting its holdings of Treasury securities for six straight months, which coincided with the period when the yuan weakened against the dollar.

There are other possible reasons for China's reduction in its Treasury holdings, some of which are long-term issues. China has sought to diversify its foreign exchange reserve portfolio and put some of it into assets other than low-yield Treasury securities, which could include foreign stocks or corporate bonds.

China's foreign exchange reserves dropped $113 billion to $3.73 trillion at the end of March, which might also partly explain the smaller holding of Treasury securities.

"But the central bank's moves to support the yuan may still be the top reason," Wang said. Even though China wants to diversify its reserves, in reality there are few choices.

Bonds in Japan and Europe have even lower yields (less than zero in some cases) and the US Treasury market remains the most liquid and popular benchmark asset around the world.

As the dollar strengthens, it also makes sense for China to invest in dollar-denominated assets, Wang said.

"The dynamic between Japan and China has shifted, in part due to foreign-exchange-reserve needs and the currency dynamics between the two countries," Edward Acton, a US government bond strategist at RBS Securities Inc, told Bloomberg News.