China and the U.S.: It's complicated

@lamonicabuzzApril 16, 2012: 1:01 PM ET
China is slowly loosening restrictions on its yuan currency. The U.S. thinks China is artificially keeping the value of the yuan low to boost exports

China is slowly loosening restrictions on its yuan currency. The U.S. thinks China is artificially keeping the value of the yuan low to boost exports. Click photo for more on currencies.

NEW YORK (CNNMoney) -- Just like rivals in a bad romantic comedy who shockingly realize they have feelings for each other, China and the United States have a complicated relationship.

The U.S. likes to complain about how it thinks China keeps its currency, the yuan, artificially low in order to make the price of Chinese-made exports cheaper.


At the same time, China has lamented the fact that the Federal Reserve may also be intentionally weakening the value of the dollar with its accommodative monetary policies. It's funny how the leaders of both countries take great pains to not use the word manipulation though.

But both the U.S. and China realize they need each other. That's why it is very interesting that China announced over the weekend it was increasing the range that the yuan could trade at on a daily basis.

In theory, agreeing to let the yuan move in a wider band going forward could mean the currency will appreciate more quickly. Of course, it will have more room to fall as well on down days.

Still, many experts said China's decision to loosen some of the constraints on the yuan should lead to a stronger currency. And it's telling that this was done just a few days before the world's financial leaders gather in Washington for a meeting of the G-20, International Monetary Fund and World Bank. It seems like a preemptive strike against criticism of its currency policy.

"China never wants to appear as if they are being told what to do. Doing this currency move before the G-20 meeting as opposed to after is very significant," said Uri Landesman, president of Platinum Partners, a hedge fund in New York.

The yuan news is more intriguing when coupled with the latest figures from the Treasury Department regarding ownership of U.S. government debt. According to a report Monday morning, China increased its Treasury holdings by nearly $13 billion in February to $1.18 trillion.

This is the second straight month that China has boosted its Treasury position. And that follows five consecutive monthly declines that started last August -- the month that Standard & Poor's downgraded the credit rating of the U.S.

Is China suddenly less worried about the long-term fiscal health of the U.S.? Perhaps. But it may simply be a case of preserving its own interests.

Chuck Butler, president of EverBank World Markets in St. Louis, said that it won't do China any good for U.S. bond yields to skyrocket if it dramatically slowed, or even stopped, buying Treasury debt. So it may simply have to begrudgingly accept lower yields and a weaker dollar.

"There is a give and take. The U.S. wants the dollar to be weaker but not for it to fall off a cliff," Butler said. "It's the same for China. So it will show up and participate in bond auctions occasionally to keep everybody happy."

Although the Treasury's foreign holdings data only is current as of February, a look at how bonds have done since then clearly shows investors have still been eager to buy U.S. debt. That likely includes China. Yields on the 10-year Treasury slipped to 1.95% Monday -- not too far from their low point for the year. (Bond rates and prices move in opposite directions.)

"It's still the same old story with China. Where else are they going to put their money?" said Paul Montaquila, vice president of fixed income trading with Bank of The West in San Francisco. "It probably irks China to keep buying, but the U.S. is still the safest haven on the planet."

Still, the increased pace of bond purchases by China may soon be coming to an end.

Kathy Lien, director of global research and analysis for GFT, a currency broker in Jersey City, N.J., said that the decision to widen the trading band for the yuan could mean that China is less concerned about a hard landing for its economy. And that may lead to fewer big purchases of U.S. debt.

Even though there was some disappointment in the global markets Friday that China's gross domestic product rose by only an annualized 8.1% pace in the first quarter, that is still an incredibly robust level of growth.

"China may be a little more confident now about its economy and it has to gradually appreciate the currency," Lien said. "The need for owning more U.S. dollar-denominated assets lessens with a stronger yuan."

Butler agreed. He said that China understands that in order for its economy to avoid a massive slowdown, it has to take more steps to boost domestic consumption and rely less on exports. Boosting the value of the yuan is one way to accomplish that.

"I think China is gearing up for a nice rebound in their economy," he said. "But they have to let the yuan strengthen in order to reduce exports and ramp up domestic demand."

And Landesman isn't convinced that China wants a stronger currency per se. He argues China must continue to loosen the shackles that keep the yuan from trading freely if it ever hopes to have the yuan supplant the dollar as the world's reserve currency.

"If you believe China's goal is to have the yuan replace the dollar, there is no way it can do that until you have free trading. This is a small step but China is extraordinarily patient," he said.

Best of StockTwits: Bank stocks rallied Monday after Citigroup reported earnings -- although there is still a lot of skepticism. And momentum darlings like Apple (AAPL, Fortune 500) and Priceline (PCLN) took a big hit, leading some to wonder if the great 2012 tech rally is over.

DavidSchawel: Citigroup CFO sees "nothing worrisome on Spain consumer business" - that sounds about right coming from $C

I hear you. It is tough to take what the big banks have to say at face value since so many investors remember getting burned badly by them during the credit crisis of 2008.

To be fair, Citi (C, Fortune 500) and other big banks are healthier now and they don't really appear to have Lehman-like exposure to Spain or the rest of Europe. However, it's the U.S. that may be the problem. As I said in today's Buzz video, there are concerns about deteriorating credit quality at Citi, JPMorgan Chase (JPM, Fortune 500), and Wells Fargo (WFC, Fortune 500) now that the job market may have stalled.

louisblank: Has anyone here ever watched what $AAPL does just before earnings release? Not this.

CDMCapital: Feel like we are seeing some mean reversion/rotation $SBUX $PCLN $AAPL $GOOG, names that ran the most getting hit hard, others flattish...

StkConfidential: More leading stocks finally starting to join the rest of the market downturn, something we haven't seen up till now.

Nobody should be surprised that Apple, Priceline, Google (GOOG, Fortune 500) and Starbucks (SBUX, Fortune 500) have hit speed bumps. However, these four all still trade at relatively reasonable valuations and are clear leaders in their respective categories. It's disconcerting that they have all tumbled lately. But it's not a reason to panic if you own them for the long haul.

Still, like I said in last week's columns about Priceline, Google and Starbucks, investors can't expect these momentum stocks to keep going up indefinitely. These pullbacks are needed ... and a smart investor that's owned any of these stocks for a while would be wise to take some money off the table.

The opinions expressed in this commentary are solely those of Paul R. La Monica. Other than Time Warner, the parent of CNNMoney, and Abbott Laboratories, La Monica does not own positions in any individual stocks. To top of page

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