What China scaled back in exposure to Treasuries last year was more than compensated by a rise in purchases of U.S. agency debt, valuation-adjusted calculations from Federal Reserve economists Carol Bertaut and Ruth Judson show. Taken as one bucket, China actually increased its combined exposure to U.S. government and quasi-government assets in 2022. Fraying relations between the two superpowers over trade, Taiwan, tech and espionage, and Ukraine - and a real risk that Western sanctions on Russia's overseas reserve holdings after last year's invasion may act as a template for a military move on Taiwan - make the case for gradual Chinese divestment. But it's still hooked on dollars. China's holdings of U.S. Treasuries last year shrank by $173.85 billion, Bertaut and Judson's figures show, the second-largest fall on record after the $189 billion slump in 2016, around the time of China's mini devaluation. Beijing's stash of U.S. government bonds ended last year at $862.3 billion, the lowest since May, 2010, according to Refinitiv data. But Bertaut and Judson estimate that valuation effects - recall that Treasuries had their worst year in decades last year - accounted for $114.4 billion, meaning the real decline in China's holdings was 'only' $59.5 billion.
This does not necessarily equate to outright selling. Some - probably most of it - was due to bonds maturing and not being reinvested. Meanwhile, China's holdings of U.S. agency bonds last year rose by $50.9 billion and valuation effects accounted for $34.8 billion. This means the real increase was $85.9 billion, substantially more than the decline in Treasuries holdings. "Every holder of U.S. Treasuries in 2022 saw significant valuation losses. China's losses are large but hardly unique," said Brad Setser, an economist who is a senior fellow at the Council on Foreign Relations.
"Maybe the big story is there is no sign that China's dollar holding portfolio has changed much. There has been no significant shift since 2015-16." HIGHER RETURNS Agency debt - bonds issued by a government-sponsored agency like mortgage provider Freddie Mac - is not backed by the U.S. government but is considered to be almost on a par. The main difference is that it is a smaller and less liquid market than Treasuries, and so often offers a slightly higher yield. China's total foreign exchange reserves stood at $3.18 trillion in January, recovering from a five-year low of $3.03 trillion in September. Around 60% is thought to be in U.S. dollar-denominated assets.
Setser notes that China's holdings of U.S. assets also include T-bills and are probably spread across third-party custody countries like Belgium, whose holdings of Treasuries have trebled in the last five years to more than $300 billion.
The shift into agencies last year suggests Beijing is willing to sacrifice liquidity for a chunk of its $3 trillion FX reserves stash in return for the higher yield on offer. The spread between the yields on the ICE Bank of America long-dated large cap U.S. agency debt index and the ICE BofA U.S. Treasury index is now 38 basis points in favor of agencies. The spread has widened consistently in favor of agencies for over a year, and turned positive last summer. "The logic is higher yield. Reserve managers are trying to minimize the bond bear market and secure a higher return. It makes sense," said Marc Chandler, managing director at Bannockburn Global Forex. As Treasury yields soar, however, that thinking may be changing - the two-year is up 50 basis points this month and close to November's 15-year high of 4.88%, while the 10-year is up 40 basis points this month and knocking on the door of 4%. China's appetite for T-bills, meanwhile, may waver due to the U.S. debt ceiling issue. But overall, it seems like Beijing is prepared to tweak the composition of its dollar assets rather than reduce its exposure to the greenback. (The opinions expressed here are those of the author, a columnist for Reuters) Related columns: - Central banks still U.S. bond buyers - but FX campaigns may jar - In global FX reserve battle, dollar to remain above the fray <^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ China's holdings of U.S. Treasuries U.S. agencies vs Treasuries - yield spread ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^> (By Jamie McGeever; Editing by Paul Simao)
Messaging: jamie.mcgeever.reuters.com@reuters.net))