European policy makers will be focused on Greek aid talks in Brussels on Monday. Investors may need to look further afield to fully explain the sell-off in the continent’s sovereign debt market.
China’s foreign currency reserves had their biggest quarterly drop on record in the first three months of the year and the yuan is trading at the closest to fair value since 2010, according Goldman Sachs Group Inc. That means less demand for assets in dollars and euros from the world’s biggest creditor.
The Chinese central bank has amassed $3.73 trillion in currency reserves over the past decade in a bid to hold down the value of the yuan and underpin the competitiveness of its exporters. As the government in Beijing changes gear, cultivating domestic demand to sustain economic growth, it may affect European bond markets just as much as the Greek efforts to win better terms from creditors.
“It’s quite clear that China’s foreign exchange reserves can’t grow like before,” said Li Jie, head of the foreign-exchange reserve research center at the Central University of Finance and Economics in Beijing. “There will be fewer and fewer funds available from China for European treasury bonds.”
The People’s Bank of China said Sunday it will reduce the one-year lending rate by a quarter of a percentage point to 5.1 percent, in a further sign of the shift in focus.

Yields Jump

Germany’s 10-year borrowing costs almost quadrupled over the past three weeks as investors turned against negative yields and those on Italian and Spanish securities breached 2 percent for the first time this year on May 7.
Bonds fell even as the European Central Bank pressed ahead with its 1.1 trillion-euro ($1.2 trillion) program of government debt purchases.
Euro-area finance ministers are meeting in Brussels on Monday to assess Greece’s plans to meet the terms of its bailout and obtain the aid it needs to stave off a default.
While officials insist publicly that the rest of the currency bloc is protected against the fallout should Greece fail to reach a deal, at a meeting in Riga, Latvia, last month some finance ministers called for contingency plans to be drawn up to bolster their defenses.
In Spain, where the risk premium on 10-year bonds surged to 141 basis points last week from 85 basis points in March, finance officials are monitoring developments in Asia alongside the wrangling with Greece.

Reserves Decline

“We are watching closely how the big Chinese investors evolve,” Jose Abad, chief economist at Instituto de Credito Oficial, Spain’s state development bank, said by e-mail. “While Greece is an element that is on everyone’s radar, it’s not big enough to move out of all markets from bunds to peripherals.”
China’s foreign-exchange reserves fell by $113 billion in the first quarter, the third straight quarterly decline, data from the central bank showed on April 14.
The yuan has been trading at an average $6.20 since April compared with fair value of $6.58, according to Goldman Sachs estimates. The 38-cent gap is the smallest since September 2010. The International Monetary Fund is close to declaring that the Chinese currency is fairly valued for the first time in more than a decade, the Wall Street Journal reported on May 3.
“They don’t need to keep building their foreign exchange reserves as the yuan is virtually floating,” Abad said.