China still has appetite for U.S. debt

NEW YORK (CNNMoney.com) -- China added to its big position in U.S. debt during the month of April, according to the latest figures from the Treasury Department.

So did Japan. And the U.K. And the big bloc of oil exporting nations that includes Venezuela, Iraq, Iran and Saudi Arabia. All told, foreigners increased their net holdings in Treasury bonds and notes by more than $76 billion.

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What did you expect them to buy? Euros?

The fiscal crisis that's gripping Europe has clearly led China and many other large foreign central banks and private investors to the realization that no matter how troubled the U.S. economy remains, the dollar and Treasurys still appear to be a safer bet than the euro.

China increased its holdings by $5 billion in April to just over $900 billion. This was the second consecutive increase after four months in which China, the largest foreign owner of U.S. debt, pulled back on Treasurys. It's also the first time that China's holdings exceeded $900 billion since November of last year.

"China has a whole new attitude on the U.S. They don't mind holding dollars and Treasurys now," said Robert Smith, chairman with Smith Affiliated Capital, a money management firm in New York.

These numbers are admittedly old but it's the most up-to-date figures we have from Treasury. Presumably, when the May holdings data is reported in the middle of next month, it will show that China and other nations continued to buy more Treasurys since that's when euro fears really came to a head.

"The flight to quality we saw started in April. But concerns about Greece and Europe more broadly hit a peak in May so foreigners likely bought more Treasurys last month," Nancy Vanden Houten, a senior analyst at Stone & McCarthy Research Associates, a Princeton, N.J.-based fixed income and economic research firm.

So what's this all mean? For one, it shows that demand for Treasurys remains fairly healthy despite the fact that the rush into U.S. debt has pushed down yields to pretty low levels. (Bond prices and rates move in opposite directions.)

The yield on the benchmark 10-year Treasury note, for example, is currently about 3.25%. And with the Federal Reserve widely expected to keep short-term rates near zero for the foreseeable future, it's unlikely that long-term bond rates will edge up significantly any time soon.

That's led some fixed income investors to wonder just how much longer China and other foreign holders of U.S. debt will be willing to tolerate such piddling returns.

But it all comes back to the issue of alternatives.

"China still has concerns about low rates and the U.S. economy and they are valid concerns, but it's a question of where are they going to put their money," said James Shelton, chief investment officer with Kanaly Trust Company in Houston. "The U.S. is the best house in a bad neighborhood. For the time being, the dollar is still the world's reserve currency."

Sure, a 10-year yield of 3.25% may be anemic, but it's better than having money invested in anything tied to the euro, which has fallen so rapidly this year you would have thought it was a toxic subprime mortgage CDO being peddled by Goldman Sachs.

"It's going to take quite a while for the euro to bounce back," Smith said. "The euro naysayers were right. It went from being a solution to a problem in the past three and a half months to falling apart."

Of course, the U.S. isn't exactly a picture of fiscal health either. Some worry that unless Washington takes drastic steps to reduce the nation's debt burden, the U.S. may eventually face problems similar to Europe's.

Still, Vanden Houten said investors appear willing to overlook the long-term financial challenges the U.S. faces -- at least for now.

"Not that the U.S. doesn't have its own problems but it does seem the U.S. is still a safe haven," she said. "Investors around the world are still pretty skittish and the things going on in Europe have people on edge. A 3% return is better than losing a lot of money."

- The opinions expressed in this commentary are solely those of Paul R. La Monica.