China is Again Buying Long-Term U.S. Treasuries . . . Does That Mean China is Betting on Deflation?

For the first time since the financial crisis started, China is again ramping up purchases of long-term U.S. treasury bonds. Indeed, according to Bloomberg:

China�s holdings of notes and bonds climbed $26.6 billion in June to $617.7 billion, a 4.5 percent increase, while bill holdings fell 25 percent to $158.7 billion, the Treasury�s data showed.

The difference between treasury bills, notes and bonds are the length until maturity:

• Bills are issued for terms less than a year

• Notes are issued in terms of 2, 3, 5, and 10 years

• Bonds are issued in terms of 30 years

Bloomberg also noted:

When the U.S. raised $75 billion last week, a group that includes international investors purchased a record amount of 3- year notes, the biggest share of 10-year notes since 2005 and almost half of the 30-year bonds sold, according to Treasury data.

Some smart people are arguing that this means that China"s head economists believe that deflation will prevail over fears of inflation.

Why?

Well, on August 14th, Bloomberg quoted the following people talking about a bond rally being tied into lowered inflation expectations:

�The relief over the inflation situation and the slippage in consumer confidence very readily justify the move upwards in the Treasury market,� said Eric Lascelles, chief economist and rates strategist at TD Securities Inc. in Toronto, a unit of Canada�s second-biggest bank. �The economic story is more consistent. The inflation data is bond-bullish.� ...

�Inflation will stay tame to surprise-to-the-downside for the rest of the year,� said Alex Li, an interest-rate strategist in New York at Credit Suisse Securities USA LLC, one of the 18 primary dealers that trade with the Fed. �It�s going to be good for the 5- to 7-year sector and longer.�

Treasuries surged yesterday as a report showing an unexpected drop in retail sales suggested inflation remains restrained, helping to spur higher-than-forecast demand at a record $15 billion auction of 30-year bonds.

�The economic recovery will be slow at best, which is more bullish for bonds,� said David Ader, head of U.S. government bond strategy in Stamford, Connecticut at CRT Capital Group LLC.

The argument by some China watchers is that China is following the same trend.

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