Pacific Silver | Economy | East Asia
Speculation that Russia could liquidate its yuan-based foreign exchange reserves spooked investors, leading to the biggest monthly loss on record.
The world’s second largest bond market was rocked in February. Faced with heightened geopolitical uncertainties amid the Russian invasion of Ukraine and tighter bond yields with US Treasuries, Western investors have exited Chinese sovereign debt in an unprecedented fashion. Foreign investors sold $5.5 billion worth of Chinese government bonds throughout the month, the largest month-over-month decline on record.
While it is clear that the sale was driven by geopolitical uncertainties, there is speculation that much of the sale could have come directly from Russia’s central bank itself. Recently imposed sanctions on Russian banking authorities have frozen their access to much of the country’s $643 billion in foreign exchange reserves. However, the country holds more than 13% of its foreign exchange reserves in yuan-denominated bonds. So Russia still has access to around $60-80 billion in cash renminbi when it sells these bonds.
Whether or not the Russian central bank called for this liquidation is uncertain; nevertheless, there were other factors that contributed to the massive sell-off. Poignantly, Chinese government bond yields have fallen in recent months as yield spreads over US Treasuries have narrowed. Trading at a yield of around 2.816%, China’s 10-year government bond is only trading around 70 basis points higher than the US 10-year Treasury. At the start of the year, there was more than 100 basis points between the two. As geopolitical tensions continue to rise, investors may continue to turn to the safe-haven asset of the US Treasury, which will drive Chinese yields lower. In fact, the 10-year note recently recorded its highest close since June 2019.
There is great uncertainty about a quick return of investor confidence, especially as various pressures are beginning to weigh on investors. In addition to short-term geopolitical worries, longer-term trends, including 2021’s regulatory crackdown, inflationary pressures and China’s strict no-COVID policy, have made investors wary. The latter is of particular concern: this week, a large-scale outbreak occurred in the southern city of Shenzhen. The lockdown is resuming in various parts of the country and up to tens of millions of citizens are facing restrictions.
Overall, the net outflow of foreign funds in February marks a surprising change for foreign holdings of Chinese government bonds, which have flourished in recent years. Since Chinese government bonds joined the FTSE Russell World Government Bond Index in October 2021, inflows from overseas investors have averaged around RMB 72 billion each month. February marks the first monthly net outflow of foreign bonds since March 2021 and only the second since the start of the pandemic.
Currently, foreign investors hold about 11% of China’s sovereign debt. Notably, many foreign bondholders expect the People’s Bank of China to engage in monetary easing before doubling China’s government debt. However, the PBoC has remained firm on monetary policy since the start of the pandemic: China’s prime lending rate, a key benchmark for medium- and long-term loans, saw only one significant ten-point reduction. basic since the height of the pandemic. . With geopolitical jitters, market uncertainty and unwavering monetary policy, Chinese markets could see more exits before things improve.