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China’s government bond market opened 2025 with a clear warning for policymakers: Without more determined stimulus measures, investors expect deflationary pressures to become even more entrenched in the second-largest economy. worldwide.
The yield on China’s 10-year bond, a benchmark for economic growth and inflation expectations, fell to a record low of less than 1.6 percent during trading last week and has since remained close of this level.
Basically, the entire yield curve has shifted downward rather than steepening, suggesting that investors are worried about the long-term outlook and not just expecting short-term reductions interest rates.
“For the long term [bonds]yields have been on a downward trend and I think this is more because long term growth expectations and inflation expectations are becoming more pessimistic. And I think that trend is likely to continue,” said Hui Shan, chief China economist at Goldman Sachs.
Falling yields provide a stark contrast to volatile and rising yields in Europe and the United States. For Beijing, the fall represents an ignominious start to the year after policymakers launched a stimulus campaign in September intended to revive the animal spirit of China’s economy.
But data released Thursday showed that consumer prices remained almost flat in December, growing just 0.1 percent from a year earlier, while factory prices fell by 2. 3 percent, remaining in deflationary territory for more than two years.
China’s central bank last year unveiled policies aimed at boosting institutional investment in stock markets and announced for the first time since the 2008 financial crisis that it was adopting a “moderately accommodative” monetary policy.
In December, a major Communist Party meeting on the economy, chaired by President Xi Jinping, for the first time focused on consumption over other previously more important strategic priorities, such as construction of high-tech industries.
The shift in focus reflects concern over consumer confidence weakened by a three-year housing crisis that has made the economy more dependent on a boom in manufacturing and exports for growth. Investors fear this strong wave of exports could slow abruptly after US President-elect Donald Trump takes office on January 20, promising to impose tariffs of up to 60% on Chinese goods.
Citi economists estimated in a research note that a 15 percentage point increase in U.S. tariffs would reduce Chinese exports by 6 percent, thereby reducing GDP growth by 1 percentage point. Growth in China was estimated at 5 percent last year.
However, deflationary pressures on the Chinese economy are more insidious than slowing growth, analysts say. Citi economists noted that the final quarter of last year was expected to be the seventh in a row in which the GDP deflator, a broad measure of price changes, was negative.
“This is unprecedented for China, with a similar episode in 1998-99 only,” they said, pointing out that only Japan, parts of Europe and some commodity producers had experienced a period of deflation as long.
Chinese regulators are aware of the parallels with Japan when it comes to deflation, said Robert Gilhooly, senior emerging markets economist at Abrdn, but “they don’t seem to be acting like it, and one thing that has helped is Japan’s example was to become small with piecemeal easing. “.
Goldman’s Shan said the central bank had promised to ease monetary policy this year, but a sharp increase in China’s budget deficit at the central and local government level would be just as significant.
How this deficit is spent will also be important. Directing it directly to low-income households, for example, could have a higher “multiplier effect” than giving it to other sectors, such as banks for recapitalization purposes, she said. declared.
According to Frédéric Neumann, chief Asia economist at HSBC, another reason government bond yields were at historically low levels was that the economy was flooded with liquidity. High household savings and low demand for business and personal loans have left banks with ample liquidity flowing into bond markets.
“It’s a bit of a liquidity trap in the sense that there’s money, it’s available, it can be borrowed cheaply, but there’s just no demand for it,” he said. Neumann said. “Marginal monetary easing is becoming less and less an effective driver of economic growth. »
Without a strong fiscal spending program, the deflationary cycle could continue, with interest rates falling, wages and investment falling, and consumers postponing purchases while waiting for prices to fall further.
“Some investors lost a little patience last week,” he said, referring to the rush into bonds. “It is still likely that more stimulus measures will be put in place. But after all the ups and downs of recent years, investors really want to see concrete figures.”
Some economists have warned that the decline in Chinese bond yields could deepen further. Analysts at Standard Chartered said the 10-year yield could fall another 0.2 percentage points to 1.4 percent by the end of 2025, especially if the market has to absorb higher net issuance of central government bonds for recovery purposes.
