China looks beyond U.S. Treasuries for dollar investments

LONDON, June 4 (Reuters) - China may be expanding its investments beyond U.S. Treasuries into debt issued by top-rated European and other government agencies, allowing it to keep its money in dollar assets while picking up some extra yield, bankers with knowledge of the matter say.

At least four investment banking officials who deal with public sector debt report a spike in interest from China in government-linked borrowers, who can offer an alternative to U.S. Treasuries.

Prominent among these are the European Investment Bank, a development bank backed by European Union countries, KfW, a German government-guaranteed institution and AIIB, a Beijing-based pan-Asian development bank that issued its first ever bond last month.

While bond buyers are publicly identified only by geography or category, bankers reckon recent Asian buying is led by China.

“We are seeing some interest from China in the likes of EIB and AIIB in dollars, which you can see reflected in the high take-up from Asia,” said one banker who sells bonds for such institutions in both euros and dollars. He requested anonymity as he is not authorised to speak about his clients.

“You also see their spread to U.S. Treasuries tightening as a result of this interest,” he added.

China is the United States’ biggest overseas creditor, holding $1.12 trillion of Treasuries through its central bank and various state-owned institutions that make up the government sector.

But with Sino-U.S. trade tensions escalating, many market participants speculate China may use U.S. Treasuries as a weapon in negotiations; recent numbers suggested it slashed its holding of U.S. government debt to a two-year low in March.

Others simply believe the Chinese, like many other investors, are exploring alternatives, given the recent drop in U.S. yields. Ten-year yields are down 60 basis points this year.

And though there are signs it is buying more euro-denominated debt than last year, China may find it tough to diversify too far into European sovereign debt given the paucity of top-rated “safe” bonds in the fragmented euro zone market.

Instead, Chinese investors are likely taking tactical positions away from Treasuries in the dollar debt of sovereigns, supranationals and agencies (SSA), a sector that includes EIB and KfW, a debt capital markets banker said.

“[China’s government] has been selectively buying the top-rated German and European-based KfW and EIB paper,” another syndicate official who deals with Chinese banks told Reuters.

Demand is also coming from the Chinese banks, which have been buying SSA paper in dollars, euros and sterling to help meet the regulatory requirements for high quality liquid assets, the same banker added.

Any Chinese move to slowly diversify reserve investments could prove problematic for the United States, which has over $3 trillion of debt maturing this year and another $1.9 trillion of debt coming due in 2020.

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Given bankers’ wariness about divulging details of deals involving China, it is hard to pin down how much Chinese investors may have purchased of recent SSA deals.

But on May 8, Asian buyers snapped up 51% of a $3 billion EIB bond issue, surpassing EMEA investors’ 35% share and that of American buyers who took 14%, data from one of the lead managers showed.

Data from International Financing Review shows that is the highest this year so far, and compares to an Asian share of 30%-38% on EIB dollar deals last year.

The trend is also discernible on KfW’s dollar issuance, with Asian takeup of its benchmark dollar issuance averaging around 32.2% this year compared to 25.1% in the whole of last year, Reuters calculations of KfW data showed.

In the January-May 2018 period, it was 23.6%.

Generally speaking, these sub-sovereign bonds trade with yields well wide of U.S. Treasuries because they have nowhere near the same liquidity. But that yield gap has narrowed of late, showing investor preference for these government-linked agencies.

EIB’s October 2024 dollar bonds for instance, have seen their spread to the five-year U.S. Treasury bond drop from 50 basis points two years ago to 13 bps currently, a recent U.S. Treasury rally notwithstanding.

While China and other reserve managers may also increasingly buy euro assets, there are strong arguments for staying within the dollar universe.

“From a policy perspective, if you move away from the dollar you run currency risk. The United States will always be a very big market and trade partner for China and it’s difficult for their mechanism to work without dollar assets.” Salman Ahmed, chief investment strategist at Lombard Odier Investment Managers.

Reporting by Abhinav Ramnarayan Graphic by Ritvik Carvalho Editing by Frances Kerry