A Simple Explanation for the Rise in China’s Reserves in June?

There are plenty of possible explanations for the surprise jump in China’s headline reserves in June.

A high allocation to yen (up around 6.5 percent), for example, or a low allocation to pounds (down nearly 8 percent).

Headline reserves are reported in dollars, and thus change when dollar value of euros, pounds, yen, and other currencies held in a typical reserve portfolio change.

But, absent a much bigger allocation to yen than to pounds, it is hard to see how currency moves in June can explain the $13.5 billion increase in headline reserves. My simple valuation adjustment actually churns out a tiny valuation loss from currency moves, so it implies a slightly higher underlying pace of reserve accumulation than the rise in headline reserves.

However, some countries—following the IMF’s SDDS standard—also report the market value of their securities portfolio. And rises in the value of a portfolio that consists primarily of bonds could easily explain the rise in China’s June reserves.

A two-year Treasury should have increased in value by about half a point, and a five-year Treasury rose by almost two points. I get bond valuation gains of very roughly $15 to $20 billion on a stylized version of China’s U.S. Treasury portfolio,* and there should also be gains on China’s euro portfolio and other fixed income assets. 5 year bunds were up a bit under a point. Extrapolating a bit, across all currencies bond market gains could have added something like $25 billion to the value of a bond portfolio that likely tops $2.5 trillion by a significant margin (not all of China’s reserves are in bonds).

Of course, it is also possible China also might have started to buy dollars in the market. This though feels like a stretch — most observers suspect China’s central bank is still selling dollars through the state banks, at least in the offshore market in Hong Kong. China seems to have wanted to make sure the CNY’s depreciation against the dollar in June was orderly, and that the CNH moved in line with the CNY. This recent Reuters article, for example, hints that China still is selling foreign currency ("further weakness was capped as the central bank was suspected of intervention to offset massive dollar demand from banks’ clients, traders said").

The uncertainty about the sign of China’s activity in the market makes the foreign exchange settlement and the PBOC balance sheet data that will be released toward the end of the month all the more important. The settlement data and the PBOC’s balance sheet data often provide a cleaner read on China’s actual intervention than the change in headline reserves.

[*] Ballpark math: if China held around $1.5 trillion in U.S. Treasuries (I added Agencies to my actual estimate and rounded a bit), with two-thirds at an average maturity of two years and one-third at an average maturity of 5 years (to fit with the data showing total returns on both maturity buckets) the mark to market gain on its Treasuries would be around $15 billion. If two-thirds were in five-year bonds and only a third in two-year bonds, that would be $20 billion. All this is very rough. Precise estimates here would stretch the technology a bit too far, given all the uncertainty about China’s reserve portfolio. Most Treasuries held in central bank reserves, according to the Treasury data, have a maturity of less than five years; see pp. 24-25 of this Treasury report.