China keeps faith in US bonds even as it sells Treasuries

CHINA may be selling down its massive pile of Treasuries but only in favour of other US government debt.

Investors in the Asian nation offloaded US$12.6 billion of Treasuries last year, according to the latest data from the US Treasury Department, but that figure was dwarfed by a record US$121.8 billion purchase of agency debt, higher-yielding securities still backed by the US government.

US agency bonds, including those of home-mortgage behemoths Fannie Mae and Freddie Mac, currently offer a yield premium of 28 basis points over Treasuries, according to a Bloomberg index. The yield on 10-year Treasuries was at 3.78 per cent as of 12.16 pm in London.

Yield-seeking looks to be the main reason behind China’s shift from US Treasuries to agency mortgage-backed securities (MBS), said Zerlina Zeng, a senior China credit analyst at CreditSights in Singapore.

“Agency MBS underperformed other US fixed income assets because of the end of Federal Reserve (Fed) purchases of MBS, rising interest-rate volatility and muted demand from commercial banks,” she said. “As a result, MBS yields and spread went up in the second half of last year, looking more attractive versus US Treasuries.”

The extra yield offered by agency debt over Treasuries has almost tripled from its low in November 2021 as the Fed raised interest rates to contain inflation. During that time, demand for Treasuries from their most powerful buyers started to wane, including Japanese pensions and life insurers, US commercial banks and even the Fed itself.

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While China is still the largest overseas holder of Treasuries after Japan, its stockpile has now fallen to the lowest level since June 2010.

The share of China’s Treasury holdings in its foreign-exchange reserves fell to 27.9 per cent as of November, from 32.9 per cent at the end of 2021, according to a research note from JPMorgan Chase. The decline “may reflect part of the State Administration of Foreign Exchange’s efforts to diversify its FX reserves allocation to different asset classes,” it said.

China is on track to buy around US$75 billion of agency bonds this year, or about half of all foreign demand for the securities, said Brad Setser, a senior fellow at the Council on Foreign Relations, a Washington-based think tank.

“China now seems willing to take on a bit more risk to get a bit more yield than it gets on Treasuries,” Setser wrote in a research note Monday. “Agency MBS traded quite wide for a while, with a substantial yield pickup over Treasuries. And China never has minded when the true scale of its reserve holdings is obscured a bit.” BLOOMBERG