China increases holdings of middle- and long-term US bonds

Chinese holdings of middle- and long-term US government bonds increased by $81.1 billion in 2013, the fastest growth pace in five years, despite the rising yields of the benchmark notes, data from the US Treasury Department showed.

Since 2009, China, the largest foreign US creditor, has increased its middle- and long-term US debt by $281.9 billion, which has provided a stable financing source for the US government.

Last year, the country's total holdings of the US debt rose by 4 percent, the second annual gain after falling in 2011 for the first time on record, according to the US Treasury.

But it doesn't mean that China will continually expand US debt holdings in the coming months, although signs of a stronger economic rebound have been seen this year, said Zhao Qingming, a professor at the financial school of the University of International Business and Economics.

"China's decision on whether to reduce or increase the US bond holdings will partly be influenced by the US Federal Reserve's policy stance in the short term," Zhao said. "To maintain the safety of our foreign exchange asset is the priority."

Compared with other investment instruments, US government bonds are still one of the optimal choices for the huge amount of Chinese foreign exchange reserves that expanded to $3.82 trillion by the end of December, analysts said.

The Fed announced plans to slow asset purchases in December, and it trimmed its $85 billion of monthly bond-buying by $10 billion in January and will cut the same amount in February.

Li Gang, a researcher at GF Futures, predicted the tapering pace of the US quantitative easing policy, known as quarterly easing, may not change this year unless a sudden economic deterioration happens.

"It means that in the near future, the Fed will continue to reduce its holdings of US government bonds and that will influence the bond prices and expected yields simultaneously. So China's investment returns from US bonds will also be affected," Li said.

After the Fed began to scale back bond purchasing, yields on benchmark 10-year notes rose to 3 percent in December, the most since July 2011. Meanwhile, US government securities prices dropped 3.4 percent in 2013, the first annual decline since 2009's record 3.7 percent loss.

China cut its holdings of US debt in December by $47.8 billion — 3.6 percent — to $1.27 trillion from $1.32 trillion in November, the largest decline since December 2011, US Treasury data showed.

Most of China's cut in holdings was for short-term government bonds, which have declined by $43.1 billion, compared with $4.66 billion middle- and long-term ones.

By the end of December, the world's second-largest economy held a total of $1.26 trillion US government bonds, lower than the record high of $1.32 trillion at the end of November, as shown by US data.

"The tapering's effect on China's accumulation of reserves is mixed," said Kent Troutman, a research analyst at the Peterson Institute for International Economics.

Troutman said while he anticipates tapering will ease pressure on the People's Bank of China to accumulate reserves, a stronger US economic environment that allowed tapering to begin will create stronger US consumer demand, creating "appreciation pressure".

"Basically, the timing and intensity of these two factors — the investment channel and the trade channel — will determine how much appreciation pressure is created on the renminbi," Troutman said.

"The Fed's taper was widely anticipated and thus I do not think this resulted in a sudden stop of appreciation pressure on China. How the PBOC responds to that pressure going forward is another matter."

In response to the Fed's reduction of asset purchases, foreign sales of the US long-term securities reached $45.9 billion in December, up from sales of $29.3 billion in November.

The sum of all foreign acquisitions in December — including long-term securities, short-term securities, and banking flows — was a monthly net outflow of $119.6 billion, much larger than the $16.6 billion outflow recorded in November.