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China's government bond market opened 2025 with a clear warning to policymakers: Without more assertive stimulus, investors expect deflationary pressures to become more entrenched in the world's second-largest economy.
China's 10-year bond yield, a benchmark for economic growth and inflation expectations, It fell to a record low Less than 1.6 percent during last week's trading and has since hovered near this level.
More importantly, the entire yield curve has shifted downward rather than steepening, suggesting that investors are concerned about the long-term outlook and are not just anticipating short-term cuts in interest rates.
“For longer-term bonds, yields have been trending lower and I think it has more to do with long-term growth expectations and inflation expectations becoming more pessimistic. I think this trend is likely to continue,” said Hui Shan, chief China economist at Goldman Sachs. .
The low yields are a stark contrast to the volatile and high yields in Europe and the United States. For Beijing, the decline represents an ignominious start to the year following policymakers' inauguration last September Stimulus campaign launched It aims to revive the animal spirit of the Chinese economy.
But data released Thursday showed that consumer prices remained close to stable in December, growing just 0.1 percent from a year earlier, while factory prices fell 2.3 percent, remaining in deflationary territory for more than two years.
Last year, the Chinese Central Bank revealed policies to stimulate institutional investment in stock markets and announced for the first time since the 2008 financial crisis that it was adopting a monetary policy. “Moderately loose” monetary policy..
An important Communist Party meeting on the economy in December, chaired by President Xi Jinping, Consumption confirmed for the first time On other strategic priorities that were previously more important such as building high-tech industries.
This change in focus reflects concerns about household morale weakened by the three-year-old real estate crisis that has made the economy more dependent on a manufacturing and export boom for growth. Investors are concerned about this range Strong exports will suddenly slow down After US President-elect Donald Trump takes office on January 20 with promises to impose tariffs of up to 60% on Chinese goods.
Economists at Citi estimated in a research note that a 15 percentage point increase in US tariffs would reduce China's exports by 6 percent, dragging down GDP growth by 1 percentage point. It is estimated that growth in China reached 5 percent last year.
Analysts said that what is more dangerous than slowing growth is deflationary pressures in the Chinese economy. Economists at Citi noted that the fourth quarter of last year is expected to be the seventh straight in which the GDP deflator, a broad measure of price changes, was negative.
“This is unprecedented for China, and a similar incident only occurred in 1998-1999,” they said, noting that only Japan, parts of Europe and some commodity producers had experienced such a long period of contraction.
Robert Gilhooly, chief emerging markets economist at Aberdeen Bank, said Chinese regulators are aware of the similarities with Japan in terms of deflation, but “they don't seem to be behaving that way, and the only thing that has contributed to the Japan model is taking small measures through gradual easing.” . “.
The central bank has promised to ease monetary policy this year, but equally important is a significant increase in China's fiscal deficit at the central and local government levels, Goldman Sachs's Chan said.
How this deficit is spent will also be important. She said directing it directly to low-income households, for example, may have a higher “multiplier effect” than giving it to other sectors, such as banks for recapitalization.
Another reason government bond yields fell to record lows is because the economy was flush with liquidity, said Frederick Neumann, chief Asia economist at HSBC. Rising household savings and falling demand for corporate and individual loans have left banks flush with cash that is finding its way into bond markets.
“It's kind of a liquidity trap, meaning there's money, it's available, it can be borrowed cheaply, but there's no demand for it,” Newman said. “Monetary easing at the margin is becoming less and less an effective driver of economic growth.”
In the absence of a strong fiscal spending package, the deflationary cycle may continue, with interest rates falling, wages and investment falling, and consumers postponing purchases while they wait for further price declines.
“Some investors have lost some patience here in the last week,” he said, referring to the rush into bonds. “It's still likely we'll get more stimulus. But after all the ups and downs of the last couple of years, investors really want to see concrete numbers.
Some economists warned that the decline in Chinese bond yields could lead to a further decline. Analysts at Standard Chartered said the 10-year yield could fall by another 0.2 percentage point to 1.4 percent by the end of 2025, especially if the market has to absorb higher net central government bond issuance for stimulus purposes.
