A wall of cash is set to hit world markets as China is to start managing its foreign exchange reserves more aggressively in a move that will see around $200bn invested globally.
China has set up a State Investment Corporation that will invest $200bn of its $1.3tn foreign exchange reserves initially and an unspecified portion of future reserve accumulation. China’s foreign reserves are growing by $40bn a month.
Henderson says the move to boost returns from foreign exchange reserves could have a massive impact on global asset markets.
Senior economist Nicholas Brooks says he expects China to reduce its purchases of new US, European and UK Government bonds, with equity investment likely to make up the biggest share of new allocations.
He says the fall in demand for Government bonds will affect their pricing while big inflows into emerging market equities could squeeze liquidity.
Brooks says: “Given the big role China plays in the US treasury market and the fact that the primary goal of the SIC’s asset allocators will be to reduce the share of these holdings, all else being equal, US government bond yields should rise. On similar logic, yields in other big, liquid developed bond markets are also likely to rise as China’s official buying slows.”
The US Federal Reserve estimates that total foreign buying of US bonds in the year up to May 2005 kept the 10-year treasury yield 150 basis points lower than it would have been without foreign investment. The analysis indicates official buying by China could account for 120 of those 150 basis points.
Thomas says: “It is not in China’s economic, financial or political interest to roil US debt markets or antagonise its smaller neighbours by creating undue upward pressure on their exchange rates and equity markets. Therefore, while the funds the SIC will control are potentially vast, political considerations would indicate that asset allocation changes will be gradual and timed to minimise their impact.”