Falling Chinese bond yields signal concern with deflation

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China’s government bond market opened 2025 with a clear warning for policymakers. without stronger 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, fell to a record low It’s down from 1.6 percent in trading last week and has been close to that level since then.

Crucially, the entire yield curve has shifted downward rather than sharply, suggesting that investors are worried about the long-term outlook and not just anticipating short-term rate cuts.

“In the long run [bonds]”yields are trending down, and I think it’s more about long-term growth expectations and inflation expectations becoming more pessimistic. And I think that trend is likely to continue,” said Goldman Sachs’ China chief. economist Hui Shan.

Falling yields are in stark contrast to volatile and rising yields in Europe and the U.S. It’s an inauspicious start to the year for Beijing after policymakers in September launched a promotion drive designed to revive the animal spirits of the Chinese economy.

But data on Thursday showed that consumer prices were close to unchanged in December, rising just 0.1 percent from a year earlier, while factory prices fell 2.3 percent, remaining in deflationary territory for more than two years.

China’s central bank last year unveiled policies to boost institutional investment in stock markets and announced for the first time since the 2008 financial crisis that it was accepting “moderately loose” monetary policy.

In December, an important Communist Party meeting on the economy, chaired by President Xi Jinping, for the first time highlighted consumption in the past over more important strategic priorities such as building high-tech industries.

The shift in emphasis reflects concerns about household sentiment, which has weakened in the wake of a three-year housing crisis that has left the economy more dependent on booming manufacturing and exports strong exports will slow down sharply with promises of up to 60 percent tariffs on Chinese goods after US President-elect Donald Trump takes office on January 20.

Citi economists estimated in a research note that a 15 percentage point increase in US tariffs would reduce China’s exports by 6 percent, which would shave a percentage point off GDP growth, compared to an estimated 5 percent growth in China last year.

More insidious than sluggish growth, however, are deflationary pressures in China’s economy, analysts at Citi said last year’s quarter 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 such an episode occurring only in 1998-99,” they said, pointing out that only Japan, parts of Europe and some commodity producers experienced such a long period of deflation.

Chinese regulators are aware of the deflationary parallels with Japan, said Robert Gilhooly, senior emerging markets economist at Aberdeen, but “they don’t seem to be doing it, and one thing that contributed to Japan’s example was that there was a bit of easing.” “.

Goldman’s Shan noted that the central bank has promised to ease monetary policy this year, but just as important will be the large increase in China’s fiscal deficit at the central and local government levels.

It will also be important how the deficit will be spent. Directing it directly to low-income households, for example, can have a higher “multiplier effect” than giving it to other sectors, such as banks, for recapitalization, he said.

Frederic Neumann, chief Asia economist at HSBC, said another reason government bond yields are at record lows is that the economy is flush with liquidity. with cash finding its way into the bond market.

“It’s a bit of a liquidity trap in that there’s money, it’s available, it can be borrowed cheaply, but there’s just no demand for it,” Neumann said “.

Without a strong fiscal spending package, the deflationary cycle could continue, with interest rates falling, wages and investment falling, and consumers delaying purchases while they wait for prices to fall further.

“Some investors here have lost a little bit of patience over the last week,” he said, referring to the acceleration in bonds specific numbers.”

Some economists have warned that the fall in Chinese bond yields could fall further, with analysts at Standard Chartered saying the 10-year yield could fall another 0.2 percentage point to 1.4 percent by the end of 2025, especially , if the market has to absorb higher net issuance of central government bonds for stimulus purposes.