The “Butterfly Effect” attempts to explain how a butterfly flapping its wings in China causes a hurricane in the United States. If the butterfly had not flapped its wings at the precise moment in space and time, the hurricane would never have occurred.
Something flapped concerning China this past week. It wasn’t butterfly wings, though; it was mostly gums.
A Bloomberg reporter tells us that the Chinese government is reviewing its holdings of U.S. Treasury securities. The reporter insinuated that China was contemplating reducing its Treasury holdings. China owns $1.2 trillion of U.S. debt.
When the Bloomberg story hit the wires, the yield on the 10-year U.S. Treasury note spiked 10 basis points. As yields on the 10-year Treasury note go, so go yields on mortgage-backed securities (MBS), and so go quotes on 30-year fixed-rate conventional mortgages.
Quotes on a prime 30-year loan, at the national level, were averaging 4.125% (and sometimes higher) this past week, according to Mortgage News Daily. This is a six-month high.
Yields on the 10-year note and quotes on the 30-year mortgage have subsequently eased. The Chinese government says it isn’t so: China’s foreign exchange regulator denied that the government would reduce its U.S. Treasury portfolio.
China isn’t necessarily doing us a favor when it buys our debt. It’s in China’s best interest.
China owns $3.1 trillion in foreign reserves. U.S. Treasury securities are the only instruments liquid enough to park the majority of these reserves. By holding U.S. Treasury securities, the Chinese are ensured of a fluid, predictable market. This matters because the U.S. dollar is the reserve currency of the world. The majority of foreign exchange and trade is transacted through the U.S. dollar.
So, it appears a butterfly didn’t flap its wings in China. Gums, on the other hand, were flapped, and not only at Bloomberg and in China.
Bond guru Bill Gross, portfolio manager at Janus Henderson Group, declared a bear market in bonds last week. Gross raised concerns among his followers that U.S. Treasury prices could slide (causing yields to rise) in 2018. Like the flight path of our Chinese butterfly, the direction of interest rates is difficult to predict (meaning difficult to accurately predict).
We mentioned last week that the economic environment for interest rates, including mortgage rates, supported rates holding at higher levels. Given the positive outlook for world economic growth, higher interest rates appear more likely than lower interest rates.
In this market, at this time, we see any pullback in mortgage rates as a good enough reason to lock. We’ll see where the butterfly takes us next week.