Trade wars

What could happen if China uses its 'nuclear option' in the trade war

Chinese scholars are reportedly looking into the so-called nuclear option in the trade war — Beijing dumping US Treasurys. 

"Many Chinese scholars are discussing the possibility of dumping US Treasuries and how to do it specifically," Hu Xijin, the editor-in-chief of the state-aligned Chinese tabloid Global Times, tweeted on Monday, setting off a debate about what the consequences would be if China divested its holdings.

While UBS strategists think it's unlikely China would sell the entirety of its holdings, they looked into what could happen just in case. To do so, they looked at the effect the Fed's tapering had on yields. 

"Through quantitative easing programs, the Fed expanded its balance sheet by about $3.5trn," the strategists wrote. "We estimated that this compressed US term premium by about 110bp. Through its balance sheet unwind of $600bn, we estimated that 10-year term premium had risen by about 20-30bp."

Therefore, they concluded that China unloading all $1.1 trillion of its Treasurys, or about 7% of the entire market, would cause the 10-year yield to climb by 30 to 40 basis points. 

But not everyone agrees that yields would go higher. In Bloomberg's daily markets email, Joe Weisenthal, the executive editor for daily news, suggested Treasury yields could actually fall.