China Sees Record Bond-Market Retreat by Foreign Investors

(Bloomberg) -- Foreign investors reduced their holdings of Chinese government bonds by the most ever last month as Russia’s invasion of Ukraine roiled fixed-income markets worldwide. 

Overseas investors sold a net 35 billion yuan ($5.5 billion) of Chinese government bonds in February, marking the largest monthly cut on record and the first reduction since March 2021, according to data compiled by Bloomberg. Their holdings fell to 2.48 trillion yuan from a record 2.52 trillion in January. 

The scale of the pullback spurred talk that some of the selling may have come from Russia as sanctions from the U.S. and European Union cut off the Russian central bank’s access to much of its $643 billion in foreign reserves. As of June, China’s yuan accounted for 13% of those reserves, according to the central bank data. Analysts at Australia & New Zealand Banking Group estimated that Russia’s central bank and sovereign wealth fund probably own a combined $140 billion of Chinese bonds.

Alex Etra, a senior strategist at Exante Data, said he couldn’t rule out the possibility of the Russian central bank selling, while the repatriation flows, particularly those of European bond funds, also contributed to the outflow. He estimated that bond funds’ outflow from China to be as much as $1.5 billion over the past four weeks.

February’s outflow marked an abrupt reversal of the recent trend. Inflows averaged 72 billion yuan a month since the end of October, when FTSE Russell added Chinese bonds to its global benchmark. In February, foreign investors also sold 28.5 billion yuan of policy bank notes.

It’s speculation but “of course possible” that the Russian central bank sold the bonds to “generate cash,” said Rob Drijkoningen, a portfolio manager at Neuberger Berman Europe Ltd. It’s also likely the reduced yield differential “plays a big role” in the outflow, he said. 

Shrinking Premium

China’s narrowing yield advantage over U.S. bonds, a result of their diverging monetary policies, has also eroded the allure of the Chinese securities. At about 2.8%, yields on 10-year Chinese bonds are about 105 basis points higher than Treasuries, compared with a gap of more than 220 basis points at the end of 2020.

The benchmark 10-year yield rose eight basis points last month, most since October amid growing bets for fiscal stimulus measures as the government targets an ambitious growth rate of 5.5% this year. Domestic banks, brokerages and funds cut China government bond holdings in February, according to Chinabond data.

Waning hopes for monetary easing have already prompted AllianceBernstein Holding LP and Pacific Investment Management Co. to sour on Chinese debt.

On Monday, Goldman Sachs Group Inc. lowered its assessment of Chinese sovereign bonds from bullish to neutral in the near term on the risk that they may come under selling pressure if funds fall short of cash amid emerging market outflows. 

“In a risk-off situation it wouldn’t be surprising to see foreign investors trim down their portfolio and hold more cash,” said Stephen Chiu, chief Asia FX and rates strategist at Bloomberg Intelligence. Foreigners held 11.14% of Chinese government bonds as of January, close to their 13% holdings of Japanese government debt, Chiu said, adding that investors may be nearing their limit for China.

©2022 Bloomberg L.P.

With assistance from Bloomberg