China has a couple of "Trump" cards to play, but dumping Treasuries may not be one of them
The trade wars rhetoric between the two nations are starting to calm down a bit - in part because China is on a break until next week - but how soon or how well negotiations between the two countries will pan out remains unclear.
Even if it does, either Trump or Xi's ego will be bruised if some form of agreement can be reached. And right now I'm not that confident that either are willing to take that in.
There are some quarters in the market that believes that China's biggest weapon against the US is its Treasury holdings and that China can offload a bunch of it should trade tensions escalate further.
I don't quite share that opinion. It's pretty counter-intuitive if you ask me, and as mentioned here yesterday, China has a better and more effective weapon in their arsenal - the Chinese yuan.
China's leverage against the US through Treasuries are only as good as the amount it holds - so dumping them in response only kills the threat. And it's not to say that China's holding of Treasuries hasn't been declining over the years, because it has.
The worst part about that move is that it would only serve to weaken the dollar (as seen here in January) and in essence weaken China's export attractiveness. So, what exactly would that accomplish? Pretty sure what it does is not what China is looking for.
Instead, using the Chinese yuan to battle back is a more sustainable and damaging tool to the US economy and Trump's ambitions. A depreciation in the yuan will only help to draw more factories to open up in China - putting a dent in Trump's plans to promote manufacturers to bring their production to the US instead.
And it's a much easier tool for China to work with, as they have done in the past. A little "tweak" in the fixing methodology by the PBOC and voila, there's your new "fair value" exchange rate for the yuan.
In my view, that's the more potent and more sensible tool for Chinese officials to deploy if we are to reach a point where trade tensions escalate higher than where they are now. So, the Treasuries market shouldn't need to worry just yet.
