China treasuries' appeal to last, overseas money now penetrates

China's treasuries could keep drawing interest from overseas investors seeking diversification, in our analysis.

This analysis is by Bloomberg Intelligence FX & Rates Strategist Stephen Chiu. It appeared first on the Bloomberg Terminal.

Foreign ownership in the market has risen to a record 10.6% amid this year's global bond selloff, not far behind the levels in Japan and South Korea.

China chasing east-Asian peers in luring global investors

Overseas investors owned 10.6% of all China's treasury (central-government) bonds held at the China Central Depository and Clearing (CCDC) at the end of February, a record high since data began in June 2014. It's now close to the levels of overseas ownership in Japan and even South Korea.

Overseas investors owned 12.6% of the Japan Government Bond market as of last September,
16.6% of the Korea Treasury Bond market as of end January, and
23.8% of the Indonesia Government Bond market as of end February.

Despite the further rise in overseas ownership this year, China's treasury yields remained somewhat uncorrelated with the moves in the U.S. treasury yields, unlike other Asian government-bond yields. Central banks are the major holders of China's bonds and accounted for 51% of all overseas holders in 2020.

Diversification capability resisted U.S. treasury selloff

China's treasury or central-government bonds have withstood the global-bond selloff this year (which was triggered by the sharp rise in long-end U.S. treasury yields) due to its low correlation with other major global and Asian government bonds. This means China's treasuries could offer diversification if added to a global-bond investment portfolio. Among the 13 ten-year government-bond yields, China's yield changes had the lowest correlation with nearly all of the other yield changes this year (see exhibit). In particular, the low and negative correlation with the U.S. could render China treasuries less susceptible to the possible scenario of a further U.S. treasury selloff.

We have used the Bloomberg function CORR <GO> to generate the correlation matrix between the differences in 10-year government bond yield levels.

Deleveraging slowed and may pick up in March

China's interbank bond market leverage ratio may rise again in March amid a more accommodative interbank-liquidity situation (see our monthly report via the right-hand panel). This ratio has risen in all the March months since 2018, with an average rise of 1.7 percentage points. Meanwhile, while this ratio still fell to 106.9% in February, the 0.3 percentage point monthly drop was less than the 1.4 percentage point drop in January. Moreover, this overall leverage ratio remains below the long-term average at 108.9% (see exhibit).

Overall leverage ratio tends to drop in the first month of each quarter, as seasonally large tax payments may drain liquidity, but may rise again on more fiscal spending toward quarter end.

Securities companies leveraged up again in February

Securities companies tend to hold bonds with more speculative purposes, and they leveraged up again as the liquidity situation improved in February. This group of bond holders added 14.9 percentage point of leverage vs. the 38.3 percentage point drop in January. That said, the other financial institutions investor group, which includes the trust companies and automobile financial companies, leveraged up the most among all investor groups, by 28 percentage points in February.

We have created tables of bond types vs. bond holders by consolidating data from China Central Depository and Clearing (CCDC) and the Shanghai Clearing House (SHCH). We group fund institutions, such as public funds, and unincorporated products, such as banks' wealth-management products and private funds, into a single class, "total funds institutions."

Overseas investors still a major fan of China bonds

Overseas investors continued to pursue China treasury bond and policy-bank bonds despite the global bond selloff in February. While one of the reasons could be due to the relatively higher difficulty for them to turn over the bonds in the secondary market vis-a-vis other major economies. Other holding reasons include higher yields and China's robust macro backdrop. Overseas investors now hold a record high 3.57 trillion yuan China bonds, accounting for 3% of China's bond market.

On the other hand, onshore commercial banks added 102.5 billion yuan of treasuries and local-government bonds in total, while reducing the holdings of policy-bank bonds. In general, the change in holdings in February was relatively small in size due to the Lunar New Year holidays and contained net issuance.

Corporate bond holdings: Credit concerns contained

Apart from the holidays factor, February data suggested that bond holders might have become less worried by the market delinquency events since 4Q20. For instance, holdings of corporate bonds like the short-term commercial papers rose for the second straight month after dropping for four straight months (an accumulated drop of 661.8 billion yuan). Total funds institutions, who has been the main seller of the short-term commercial papers, added back short-term commercial papers finally after cutting back holdings for nine straight months.

Holdings of commercial-bank bonds up again

Holdings of Chinese commercial-bank bonds rose again in February, driven by the addition from both insurance institutions and unincorporated products.

NCD in demand while Yulan bond debuted

Negotiable certificates of deposit saw the largest increase in holdings out of all bond types in February. The 368.5 billion yuan monthly jump in holdings was the largest in seven months, and was led by the 264.2 billion yuan demand from the total funds institutions (mainly the unincorporated products), with this investor group offloading the treasury bonds at the same time. This is also consistent with the net issuance of NCD at 495.9 billion yuan, as contained NCD yield amid less interbank liability pressure lured supply.

SHCH started reporting the total holdings of Yulan bonds in February (3.2 billion yuan), yet the investor-holding breakdown is not available yet. Yulan bonds are denominated in U.S. dollars and euros and are issued through SHCH, but global investors settle this new asset class within Euroclear's network.

Analysis can reveal investors' appetite

Monthly bond-holding data may explain investor preferences for different types of bond in China. In general, holdings are concentrated in government bonds, policy-bank bonds and NCDs, with commercial banks or total funds institutions serving as the main holders. Meanwhile, insurance companies tend to focus on longer-tenor bonds to match their liabilities. Overseas investors remain minor players in the market, but their influence may grow as China opens up.