China’s bond purchasing games | FT Alphaville

China’s bond purchasing games

Beyond the spotlight glaring on China’s leader Hu Jintao as he kicks off his US visit are some intriguing movements in Beijing’s foreign reserves management.

First, we had China’s pledge to buy eurozone bonds amid its recent charm offensive in Europe.

Then we had reports last week that China sold off a net Y81.3bn of Japanese government bonds in November. That was barely two months after Beijing provoked alarm in Tokyo with its record buy of JGBs in July.

Now, it emerges that China was among the top sellers of US Treasuries in November. As the FT reports:

China and Russia were the major sellers of US Treasuries in November as bond yields surged sharply higher that month, according to the latest government data. The US Treasury reported on Tuesday that private investors sought more dollar-denominated stocks and bonds in November than October, offsetting record sales by foreign governments.

Net purchases of US long-term equities, notes and bonds were $85.1bn in November, the highest level since August, and up sharply from net buying of $28.9bn in October. Official foreign investors sold a net $40.8bn of US assets, eclipsing the earlier peak of $38.7bn selling recorded in May 2010. Net purchases made by private investors amounted to $79.8bn.

These flows occurred as the yield on 10-year notes jumped from a low of 2.46 per cent to a high of 2.96 per cent during the first half of November. The rise in yields followed the Federal Reserve starting its second round of purchases of Treasury debt, known as quantitative easing, that month.

China remained the largest foreign holder of US Treasuries but its portfolio shrank $11.2bn to $895.6bn in November, the report added. Some analysts see the flows as post “QE2” profit-taking — particularly for China, which boosted its Treasury holdings in the months before the Fed launched its new bond buying programme.

Alan Ruskin, a Deutsche Bank strategist, told the FT it was “too early to infer that China is shifting its diversification stance after a period early in the year when it appeared reluctant to add to US dollar assets.”

But as the WSJ noted, the timing of the data, just hours ahead of Hu’s official visit to Washington, could add to fears that any significant sale of Treasuries by China will drive up borrowing costs for US consumers and business — and hurt the US economy.

Similar concerns plagued Japanese investors last week, following news of China’s November JGB sales. However, several analysts including Mizhuo Research Institute in Tokyo ruled out any diabolical plot by Beijing to dump JGBs — not least because China bought a net Y262.5bn of Japanese financial assets in October, according to Ministry of Finance current account data.

But some commentators, such as Hong Kong-based research house Gavekal have dark theories – especially when it comes to China’s JGB sales. As it noted in a recent client newsletter:

At this time last year, China was making headlines for its sudden appetite for JGBs. An appetite which left most scratching their heads as to whether China was trying to push up the yen? Send a message to Washington? Or simply blindly looking into the rear-view mirror when allocating to bonds? As it turns out, it now seems that China has lately been busy unloading the hoard of JGBs it bought in the second half of last year (according to the latest MoF data), leading one of our readers to ask us: ‘were you expecting the Chinese to be active punters of foreign bonds?’

But there may also be more to the about-face, Gavekal continues:

1. Politics?: China may have bought a bunch of JGBs when the [ruling] DPJ came to power as a ‘measure of goodwill’ towards the DPJ – and animosity towards the LDP …  And then, a few months later, when the DPJ imprisoned a Chinese boat captain, it became clear that not much had changed in a Chinese-Japanese relationship marked mostly by fear and mistrust. With that, the Chinese sold their JGBs…

2. Monetary Policy?: China’s diversification into JGBs and other assets might have been a signal to the US amid mounting political pressure on RMB manipulation, that China can purchase other assets than UST. However, with Treasury pressures on the RMB now somewhat abating… the need for JGB accumulation is no longer there. A variant of this is that China is importing a lot from Japan, and with the inflation problems China is experiencing, maybe China wants to weaken the yen somewhat to reduce its import bill?

3. Portfolio Diversification?: Perhaps China’s decision to buy JGBs was primarily ‘quant driven’ in that in 2008 and 2009, JGBs were the best diversification for a portfolio as each time the markets wobbled, the Japanese repatriated their cash and JGBs and the yen went up. However, this is no longer the case. In this latest Irish/Portugal/Spain hiccup, the yen has not really shot up and JGBs have been weak. So maybe the Chinese are letting go of their JGBs because they no longer provide the diversification that they use to?

The simple fact is that both politically and economically, China is making a big push to woo Europe, it’s more or less giving a cold shoulder to Japan, and it is warning the US not to push it around. Its sovereign investments partly reflect such geo-political and economic considerations, and the growing need to diversify its vast store of FX reserves.

As Gavekal concludes, “investing $2.8 trillion is not as easy as it sounds”.

Related links:
In-depth report: China shapes the world –
Hu visit is one stop on a much longer journey – FT
Hu’s feel-good tour of the US likely to be a bit chilly – WSJ
US Treasuries – Lex