beyondbrics

While recent data told us that China has increased its overall holdings of US Treasuries, there are some suggestions that its buying focus is shifting to the other side of Atlantic.

If that’s right, then China’s foreign exchange reserves must be going elsewhere, and the smart money points – of all places – to the eurozone. 

Standard Chartered’s Stephen Green and team have been looking at the rate of foreign exchange reserve accumulation compared the total buying of US Treasuries in London, Hong Kong and China. China – via the State Administration of Foreign Exchange (SAFE) has often ‘disguised’ the level of its US debt purchases by buying through brokers in London and Hong Kong – hence the use of a combined figure.

What Green found is that the gap between China’s FX accumulation and the total amount of US debt being bought in those three places is currently at its widest – their figure is $150bn in Q1 alone.

So – what’s going on?

While there’s a chance that China has found new ways to disguise its purchases of Treasuries – more likely, says Green, is that it is buying something else instead. But what?

Despite the continuing debt malaise in the eurozone, Europe remains the only market big enough to meet Chinese demand.

China has been a big buyer of AAA-rated bonds issued by the European Financial Stability Facility (EFSF), the bailout vehicle which is guaranteed by the member governments. It has been a less big buyer of European Financial Stability Mechanism (EFSM) issues, which are backed by the EU Commission, and which are also AAArated. We estimate that China bought 10-15% of EFSF issuance in May and a similar amount of the first EFSF issue, putting its investments at EUR 1.5bn. China’s EFSM purchases in the first five months of 2011 probably amounted to about EUR 1bn, or 4-6% of total issuance. This amounts to some USD 3.6bn of buying by China. This is small change compared to the USD 150bn of unexplained reserves.

However, we expect China to have been at least as active in the standard euro (EUR)-denominated bond and EMTN markets, which include corporate issuance. If we assume that China bought 5% of the USD 1.446trn issued year to date, this would come to USD 72bn. Bond issuance by Germany (AAA) and France (AAA) is about EUR 50bn each per quarter, which would come to about 80bn each in the first five months of the year. If China had bought 10% of that, this would explain USD 24bn. It is possible, if not likely, that China has been an even bigger buyer. Thus, EUR issuance could explain the gap.

Wen Jiabao will be on his way to Europe at the end of the week, with the eurozone debt crisis high up on the agenda. Is there a Chinese version of ‘Don’t fight the Fed’?

‘Stick with SAFE’, perhaps?

Related reading:
Beijing: Greece could hit us too, beyondbrics