What could happen if China uses its 'nuclear option' in the trade war

 May. 16, 2019

Earlier this week, the editor-in-chief of the Global Times, a state-aligned Chinese tabloid, said Chinese scholars were looking into the possibility of China dumping US Treasurys.

• UBS looked at the Federal Reserve's tapering to try and figure out what kind of effect China selling $1.1 trillion of Treasurys would have on the bond market and concluded the 10-year yield could rise by up to 40 basis points.
• Bloomberg's Joe Weisenthal thinks yields could actually fall if China sold its holdings.
• The debate is likely for naught as China needs to hold Treasurys, according to one analyst.
• Visit Markets Insider's homepage for more stories.

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Chinese scholars are reportedly looking into the so-called nuclear option in the trade war — Beijing dumping US Treasurys. 

"Many Chinese scholars are discussing the possibility of dumping US Treasuries and how to do it specifically," Hu Xijin, the editor-in-chief of the state-aligned Chinese tabloid Global Times, tweeted on Monday, setting off a debate about what the consequences would be if China divested its holdings.

While UBS strategists think it's unlikely China would sell the entirety of its holdings, they looked into what could happen just in case. To do so, they looked at the effect the Fed's tapering had on yields. 

"Through quantitative easing programs, the Fed expanded its balance sheet by about $3.5trn," the strategists wrote. "We estimated that this compressed US term premium by about 110bp. Through its balance sheet unwind of $600bn, we estimated that 10-year term premium had risen by about 20-30bp."

UBS

Therefore, they concluded that China unloading all $1.1 trillion of its Treasurys, or about 7% of the entire market, would cause the 10-year yield to climb by 30 to 40 basis points. 

But not everyone agrees that yields would go higher. In Bloomberg's daily markets email, Joe Weisenthal, the executive editor for daily news, suggested Treasury yields could actually fall.

"What's more plausible than spiking yields is that if word got out that China really did want to dump U.S. debt in size," he wrote.

"Yields would fall because people would assume that this 'nuclear option' represented a gigantic break in the U.S.-Sino relationship. All that would hurt the global economy, causing the Fed to be even slower with expected rate hikes. In the immediate term, there would likely be a flight to Treasuries, amid a big risk-off move in markets. The Treasury market often behaves counterintuitively," he added. 

Of course, the whole debate is likely for naught.

"What people don't understand is that it is not a choice" for China to keep so many Treasurys, J Capital Research cofounder Anne Stevenson-Yang told Business Insider's Linette Lopez. "This is a dollar world and China hold Treasurys to manage its trade with the world."

Selling Treasurys is a "good meme for the Chinese people but it doesn't actually mean anything," she said.