Stocks slipped at the open on Wednesday before recovering in mid-day trading. But it wasn’t enough to prevent the first down day for the market so far this year, breaking a historic New Year’s rally.
The catalyst was reports overnight that China could be reconsidering its foreign exchange reserve holdings in U.S. Treasury bonds — a major source of buying demand that has for decades helped keep American borrowing costs low. Reports set off speculation on whether this is potentially a politically-motivated move, an economic threat to counter President Trump’s reported exploitation of a “Bloody Nose” attack on North Korea’s nuclear weapon infrastructure, for instance.
In the end, the Dow Jones Industrial Average lost 0.1%, the S&P 500 lost 0.1%, the Nasdaq Composite lost 0.1% and the Russell 2000 lost a fraction. Gold and crude oil moved higher. The dollar weakened. And the iShares Barclays 20+ Yr Treas.Bond (ETF) (NASDAQ:TLT) fell below its 200-day moving average for the first time since May.
Breadth was negative, with decliners outpacing advancers by a ratio of 1.6 to 1. Aluminum and airline stocks carried the day, with Boeing Co (NYSE:BA) up 0.6%.
REITs and telecoms were hit the hardest on the yield drag, down 1.9% and 2.4% respectively.
Conclusion
Just after 5:00 a.m. EST, Bloomberg reported that Chinese officials were reconsidering their U.S. Treasury bond holdings. Considering China holds $3.1 trillion in reserve holdings, this is a big deal and market initially reacted violently. A strong Treasury bond auction during the trading session calmed nerves but the threat lingers.
This could result in very bad things for the bond market for a few reasons. One, the flow of quantitive easing bond buying stimulus from global central banks will soon turn negative (witness the Bank of Japan’s decision earlier this week to taper its purchase pace). Two, thanks to the GOP’s tax cut plan, the supply of debt being issued by the U.S. Treasury is set to rise.
And three, the Federal Reserve is actively working to lift interest rates at a time when the stock market’s performance is increasingly reliant on the flow and availability of cheap credit via debt-funded share buybacks and M&A activity.
The team at Capital Economics isn’t that worried, however, noting that China’s holdings of Treasury bonds have remained more or less stable in recent years and that any shift away would risk lowering the value of their own holdings.
Still, this isn’t likely to be the end of concerns about the bond market in what is emerging as they key theme for 2018: The risk of a disorderly rise in interest rates caused by bond market weakness spilling over into stocks.
Check out Serge Berger’s Trade of the Day for Jan. 11.
Today’s Trading Landscape
To see a list of the companies reporting earnings today, click here.
For a list of this week’s economic reports due out, click here.
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Anthony Mirhaydari is the founder of the Edge (ETFs) and Edge Pro (Options) investment advisory newsletters. Free two- and four-week trial offers have been extended to InvestorPlace readers.
