Thread by @BobEUnlimited

The biggest unpriced duration supply risk is that the PBOC will need to intervene to support the CNY.

CNY at 15 year lows means not too much longer before the PBOC mounts a more aggressive defense. Last time they did, it created a huge ripple through global markets. Thread.

While the PBOC has plenty ammo to prop up the CNY, it could still have huge implications on global markets.

The last time they supported their FX by selling treasuries it had a huge impact on US asset markets. Today it would exacerbate duration supply:

https://twitter.com/BobEUnlimited/status/1567489208394158083?s=20

And odds are they will turn to these assets again today.

For decades the PBOC has been very tightly managing the currency to ensure stability, though the nature of that dynamic has changed.

Until roughly 2017 the PBOC largely intervened using their balance sheet of foreign assets (usually US treasuries). When surpluses were in place (05-14) they bought US bonds to keep their FX down. When selloff pressures emerged (14-17), they sold those bonds.

The PBOC buying and selling wasnt price sensitive which meant that its impact in many ways was similar to either QE or QT since the Fed of course isnt price sensitive.

More purchases meant more liquidity and less meant less liquidity into US dollar financial assets.

Its no surprise that the greatest bubble most of us have seen - the US housing bubble - was effectively financed by this liquidity.

Or that when the PBOC was forced to sell that it created a big drag on US asset markets.

But the nature of the PBOC intervention has changed in recent years with a pretty big shift away from just buying (selling) treasuries.

In response to renewed surpluses in 2017 the PBOC got *creative* about how those were recycled.

Instead of intervening to hold liquid US bonds, they money got channeled through state owned (or directed) banks which then went into all sorts of lending like belt road etc.

@Brad_Setser has been the best at covering these shifts in recent years:

bloomberg.com/news/articles/…

When times were *good* this approach to recycling surpluses is very effective. It keeps the reserves figures stable, eases upward pressure on the FX (as desired), and helps create increased political and economic power abroad.

The problem with these types of assets is that when times are *bad* these assets are not usable to intervene in the FX. They are too illiquid to be able to quickly get access to liquidity.

Now of course there can be some clever financial engineering to swap those assets from dollars to CNY to help support the CNY in the short-term, but its not clear that will work at enough scale or coordination.

Instead it seems much more likely that the PBOC turns back to its pile of highly liquid treasury securities.

There are some signs that in the acute issues in '22 the PBOC engaged in some reserve sales, so its not as if they would *never* do such a thing.

And heck isn't now as good a time as any to do it given the other pressures on US duration? Plus the geopolitical tensions?

The trouble for the US is it doesn't take much selling for China to create a huge ripple in the US duration markets.

A 50bln or 100bln sale of duration per month in times of stress wouldn't be all that substantial for the PBOC which holds 3tln in liquid assets.

But it would have huge implications on the duration markets in the US. Essentially double QT.

While many bears focus on the implications for China, the big risk is to the US duration markets. This magnitude of supply combined with elevated issuance and QT could easily be enough to create the rise in rates necessary to topple financial assets and the economy.