Global Funds End Two-Year Buying Spree in China Government Debt
(Bloomberg) — Global funds trimmed holdings of China’s government debt for the first time in two years in March, as their yield premium over Treasuries narrowed and authorities announced plans for more debt sales.
Foreign investors held 2.04 trillion yuan ($312 billion) of Chinese government bonds as of the end of last month, data from ChinaBond show. That’s 16.5 billion yuan lower than the record amount held in February, according to calculations by Bloomberg. The last time overseas institutions cut holdings was February 2019.
While Chinese bonds have emerged as a haven during the global debt rout this year, the surge in Treasury yields to levels last seen in January 2020 have dimmed their appeal. Inflows may also slow after FTSE Russell said last month an inclusion of the nation’s debt into its global index will take three years, instead of the 12 months initially envisioned, after feedback from investors.
“While rising Treasury yields always pose a risk of capital outflow from emerging markets, net selling is very rare,” said Dariusz Kowalczyk, chief China economist at Credit Agricole CIB in Hong Kong. “The data indicate that going forward, foreign interest in CGBs and Chinese bonds in general is likely to be more limited as long as Treasury yields are high or rising, which will be the case for the rest of the year.”
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Global funds had been piling into Chinese sovereign debt for 24 consecutive months, doubling their holdings over that period as the government loosened ownership restrictions and the securities were included in global indexes. A lack of correlation to overseas bonds has also lured investors, helping them gain 1% in the first quarter, the only one to do so among the 20 largest global markets.
The yield premium China’s benchmark 10-year bond enjoys over Treasuries narrowed by around 1 percentage point to about 154 basis points from a record high in November. That advantage looks set to erode further with some on Wall Street forecasting that U.S. yields will climb to 2%.
To top it off, the slower-than-expected inclusion into FTSE Russell’s World Government Bond Index comes just as inflows from China’s entry into other major benchmarks are more or less complete. Global funds own about 11% of the Chinese sovereign bond market.
“We are in a pause between bond index inclusion by Bloomberg-Barclays and JPMorgan, which has finished, and by WGBI, which will only start in October,” said Credit Agricole’s Kowalczyk. “This means downside risks for inflows into Chinese bonds and upside risks for their yields this year.”
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The reduction in foreign interest also came after China announced a larger-than-expected quota for the sales of local government debt, with some analysts saying that would pressure the overall market. While sovereign bonds are more popular with foreign investors, Chinese commercial banks are the main buyers of local debt.
The ChinaBond data cover the majority of the interbank market, where most government and policy bank notes are traded. More figures will likely be released by the Shanghai Clearing House in a few days that will cover some credit bonds in the interbank and exchange markets.
“Offshore investors may temporarily adjust their holdings of Chinese government bonds but they will not stop buying,” said Xing Zhaopeng, senior China strategist at Australia & New Zealand Banking Group Ltd. in Shanghai. “Index flows will restart with the FTSE inclusion beginning in October while a big trade surplus will continue to support the renminbi and offset the strength of the dollar.”