China's Hidden Leverage: How Beijing Can Spook the US Treasury Market

The US Treasury market has been experiencing instability in recent years, with yields on 10- and 30-year bonds shooting up since the Iran war. In response to this trend, the US and Japan recently undertook a joint market intervention to prop up the value of the Japanese yen. However, the mechanics of this transaction have raised eyebrows, as it involved selling Euro reserves to buy Yen, rather than dollars.

The use of Euros in this transaction has led to a disquieting market interpretation: that the US involvement was aimed at ensuring the stability of the US bond market, which is unusual given that treasuries are considered the safest assets in the global economy. However, the US Treasury market has become less stable due to various factors, including inflation and unsustainable debt dynamics.

China's foreign exchange reserve management has undergone a fundamental overhaul since 2015, with Beijing shifting its dollar accumulation from central banks to state-run commercial banks. As a result, China is now holding over $1 trillion in shadow reserves, which gives it the ability to operationalize treasuries as a soft weapon against the US.

With this newfound leverage, China can sell American bonds and hike up treasury yields, forcing an extremely indebted country's borrowing costs further up. This development has significant implications for the global financial landscape, particularly in the context of the ongoing trade tensions between the US and China.