Big Trouble in Little China Causes Bond, Dollar to Rise

Bond prices and the U.S. dollar both rose today, propelled upwards by speculation concerning current fiscal policy in China.

The 10-year note increased to 98/32 from 87/32, with the yield declining 0.04% to 3.59% on Monday afternoon. The 30-year bond also rose, reaching 97-26/32 from 77-26/32, with a yield of 4.51%. This movement was based on the rising price of the dollar, which gained 0.5% against the euro and and 0.7% against the pound.

Why the movement? News out of China suggests that the Chinese government is drawing back lending in its banks to keep price bubbles from forming in various markets, for fear that the Chinese economy is running too hot. The funding squeeze in Chinese banks precipitated a rise in the dollar as investors looked for a safer place for their money - although the yen achieved a more impressive increase.

The dollar fell 0.7% against the yen today.

What does this mean for the near term? As China draws back on its lending through its banking network, you can expect the USD and yen to both rise - although I wouldn't expect the USD to make any significant gains on the yen. With that being said, news that Japan's debt rating might be cut could drop the yen and cause the USD to pick up.

And for those concerned about the title, you can relax a bit. I wouldn't go as far as to say that China is in big trouble. Any substantial growth in this economy is great, and I'd rather pull back to avoid running hot than to try and jumpstart a sluggish recovery. If commodity prices - particularly in aluminum, copper, and oil - drop, then expect a decline in the Shanghai and Shenzhen Composite Indices.