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When China pays down its reserves, it no longer diversifies its holdings — or in other words, sells dollars to move into other currencies. That practice weakens the dollar. So in recent years the euro has strengthened when China is piling up dollars, and fallen when it is not. Sales of dollars would weaken the euro, and also the already stretched emerging market currencies. And they would means higher yields on short-term US bonds, in which reserves are held. That, Deutsche says, could mean “quantitative tightening”. US yields would rise, doing a job otherwise done by the Fed.
The Fed is right to watch China — even if it perhaps scared the markets by saying it so clearly.
When China pays down its reserves, it no longer diversifies its holdings — or in other words, sells dollars to move into other currencies. That practice weakens the dollar. So in recent years the euro has strengthened when China is piling up dollars, and fallen when it is not. Sales of dollars would weaken the euro, and also the already stretched emerging market currencies. And they would means higher yields on short-term US bonds, in which reserves are held. That, Deutsche says, could mean “quantitative tightening”. US yields would rise, doing a job otherwise done by the Fed.
The Fed is right to watch China — even if it perhaps scared the markets by saying it so clearly.
