By Ben Bauer

Stocks have been taking it on the chin ever since end of the year and bonds have improved but not nearly as much as one would think, why is this? The main reason is because China, which holds 1.2 trillion in our debt via Treasury bills has been selling large amounts to try and control their currency devaluation. To give you an idea of just much they are selling, in December alone they sold 100 billion, and this is clearly adding pressure in our bond market. As more supply (China selling) comes to market it causes our bond prices to fall and the rates to rise. So why is China selling so much of our debt? Well, they have started to devalue their currency against other currencies in order to make it more attractive for companies to use China again as a manufacturing base to have things made. The problem is that money is now rushing out of China as investors try to protect their wealth/assets. Why are investors doing this? Well, let’s say you own a bunch of assets held in the Chinese currency and the government/central bank is devaluing the currency (reducing the value of the currency) this means they are reducing the value of your assets and so to protect them you want to get them out of Chinese currency. This is causing a massive capital flight (money leaving China) and as this occurs the Chinese currency devalues even further. This becomes a self-feedback loop and China looks like they could be losing control of the process. So to try and stop the devaluation process from getting out of control they are selling dollar denominated Treasury bills (selling US Dollars) they own to then buy the Chinese currency to try and support it and offset the massive capital outflow which last years was supposedly over a trillion dollars. This is why in the face of a terrible stock market bonds are not really improving. I believe at some point one of two things will occur, the Chinese currency will stabilize and the selling of T-Bills by China will stop or the Chinese are forced to stop selling T-Bills because it is costing them too much to try and support the currency. Either way, once the selling stops or slows we will see bonds really improve. The Chinese economy is in trouble as shown by these actions and the fact that the industrial commodities have absolutely collapsed worldwide due to overcapacity and falling demand. Global trade is down, Canada is in a technical recession, US manufacturing is in a recession, High Yield credit is in trouble and US corp earnings are falling….all of this spells trouble for equities and should supports bonds once the Chinese stop selling.