First, it was a swoop on Japanese government bonds in May. Then a modest but intriguing spree in the Spanish sovereign bond market in July – all amid a steady sell-off of US Treasuries.
As the latest US TIC data indicated this week, Chinese holdings of Treasuries fell to a more than one-year low of $843.7bn in June, after cuts in both long-term and short-term Treasury purchases.
As Zero Hedge noted: “China now has almost $100bn less in USTs compared to the peak of $940bn in July 2009. One wonders what China is buying with the sale/maturity proceeds.”
To answer that one, just look to Asia, as Beijing is doing. Even as it made record purchases of JGBs in May, China further accelerated its diversification push, more than doubling its South Korean debt holdings this year.
As Bloomberg reports on Wednesday, Korean Treasury bonds held by Chinese investors rose 111 per cent to 3.99 trillion won ($3.4bn) in the first half of the year, according to the Seoul-based Financial Supervisory Service. The move, notes the report, spurred the longest rally in Korean government bonds in more than three years.
Beijing’s rationale, Ding Zhijie a former adviser to CIC, China’s key sovereign wealth fund, told Bloomberg, is that China should allocate some reserves to “financial assets in major Asian economies”. In his view, “the significance of both the dollar and euro has declined because of the global financial crisis and the European debt crisis, while the role of some emerging-market currencies rose”.
Beyond emerging markets, the yen – or namely JGBs – figure prominently in China’s portfolio. Essentially, China sees JGBs as less risky than US Treasuries, Zhang Ming, an economist at the China Academy of Social Sciences, a government-backed think tank wrote in a recent paper.
As Dow Jones reported, Zhang reckons that as a greater proportion of JGBs is held domestically in Japan, it makes them relatively more stable than US Treasuries – and, he added, the yen is likely to stay strong against the dollar in the near term. Whether China will keep increasing its JGB holdings, however, is another question, he noted.
After its purchase of Y541bn ($5.8bn) worth of JGBs in the first four months of 2010, China bought a record Y735.2bn worth in May, for a total net purchase of ¥1.72 trillion in short-term JGBs (less than one-year maturity) in the first half, up from ¥41bn in the whole of 2009.
In a slightly more cynical view of China’s JGB moves, CLSA strategist Christopher Wood noted in his most recent Greed&Fear client newsletter (our emphasis):
These purchases reflect primarily China’s ongoing need to diversify away from the US dollar given the massive exposure of its foreign exchange reserves to that currency.
Meanwhile, the continuing bull market in JGBs has further delayed the day when Japan must confront the consequence of its continuing massive build-up in government debt. On that point, JGB issuance is currently forecast at 9% of GDP this fiscal year.
The above is why it only makes sense to speculate on a Japanese government bond market collapse if investors are willing to take a five-year view. And that only make sense if investors pay very little time premium for the duration of the bet.
And, in a typically dark prediction, Wood warns, don’t dismiss the possibility that “10-year JGB yields could revisit their lows of 0.44% reached in June 2003″.
Yes that “might seem ludicrous” he says, adding: “But it is certainly possible if the yen continues to strengthen and if the US 10-year Treasury bond yield heads towards 2 per cent. Remember it is in the nature of Nippon to take trends to extremes”.
And on the financial front, such thoughts could well be fuelling Beijing’s concerted diversification push.
Of course, as Bloomberg reminds us, China’s holdings of South Korean notes account for little more than 0.1 per cent of its $2.45 trillion in reserves – compared with the $20.1bn Beijing has pumped into Japanese debt. But alongside signs of China’s growing interest in other markets such as Spain, you can expect to see more such purchases in unlikely places.
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Meanwhile, in the Chinese bond market…
At the same time, China is moving to open its domestic capital markets to attract foreign-held renminbi investment and further internationalise its currency.
As the FT reports on Wednesday, foreign central banks and overseas lenders will be able to increase investment in China’s domestic interbank bond market.
Among the foreign investors China is moving to draw into its Rmb19,500bn ($2,870bn) interbank bond market are central banks, lenders in Hong Kong and Macao that already conduct renminbi clearing, and overseas banks involved in renminbi cross-border trade settlement.
The move could have broader implications. In fact, reports Bloomberg, alongside key reforms to China’s financial markets – particularly the A share stock market – some analysts see it as the potential start of China’s very own financial ‘big bang’.
In other words, you haven’t even begun to see what “diversification” means in Chinese — yet.
Related links:
Clutching at the Chinese – FTAlphaville
The end of Chimerica – the shortening of the cycles - FTAlphaville
Saying ‘mine’s bigger than yours’ in Chinese – FTAlphaville
The world is enough for US Treasuries (maybe) – FTAlphaville