Can trouble in China's economy cause a sustained selloff in Treasuries? The latest leg down in bonds has certainly coincided with a worsening outlook in China and intervention in the yuan, so I think there is a connection.
Others -- including fixed income analysts at BMO -- think that China isn't likely to have a lasting effect, even if it could be having an outsized effect now.
We’re open to the assertion that developments in China hold the potential to drive a more meaningful share of the price action – at least until Jackson Hole. As state-owned banks have been instructed to help defend the yuan and with CNY to nearly its cheapest level versus the dollar since 2007, there are two primary reasons we’re skeptical the flows related to currency control will be enough to recast the rates landscape. First is the historical precedent and our previously-offered observations that in a world where China is slowing, the global outlook dims and that impulse is more than sufficient to overwhelm the impact of the China-specific outflow. Second, and relatedly, is the evolution of China’s Treasury holdings both on an outright basis and as a share of the overall Treasury market. As our included chart shows, per the TIC data, China’s Treasury holdings have dropped from $1.3 trn in 2014 to $835 bn in June – the lowest since May 2009. Over that same time, marketable debt outstanding has grown by $19.3 trn, which has in turn pushed China holdings as a percent of the overall market from 14.0% to just 3.4%. This means for the same dollar amount of selling, the aggregate market influence is far less now than it was nine years ago. There is one aspect of the market that will see a larger influence from China’s development over the past decade and that will be commodity markets and demand from a Chinese economy that is 2.5x larger than it was at the end of 2009.
Here's their chart on China bond holdings:
Whatever the source of bond selling, it's ebbed today with 10-year yields down 1.2 bps to 4.33% and 30s down 4.6 bps.
