China’s government bond market has opened 2025 with a stark warning for policymakers: Without firmer stimulus, investors expect deflationary pressures to become even 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 of less than 1.6 percent in trading last week and has remained near that level since.
More importantly, the entire yield curve has shifted downward rather than steep, suggesting that investors are alarmed about the long-term outlook and not just anticipating short-term interest rate cuts.
“For the long term (bonds), yields have been on a downward trend, and I think that has more to do with long-term growth expectations and inflation expectations becoming more pessimistic. And I think this 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 US. For Beijing, the decline represents an embarrassing start to the year after policymakers in September launched a stimulus drive designed to revive the animal spirits of the Chinese economy.
But data released on Thursday showed that consumer prices remained close to flat in December, rising just 0.1 percent from a year earlier, while factory prices fell 2.3 percent, remaining in the territory deflation for more than two years.
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China’s central bank last year unveiled policies to stimulate investment by institutions in capital markets and announced for the first time since the 2008 financial crisis that it was adopting a “moderately loose” monetary policy.
On Friday, it announced a “supply shortfall” that meant it would halt its program that has seen it buy a net Rmb1 trillion of government bonds on the open market.
A major Communist Party meeting on the economy in December, chaired by President Xi Jinping, emphasized consumption for the first time over other previously more important strategic priorities, such as building high-tech industries.
The shift in emphasis reflects concern over household sentiment weakened by a three-year property crisis that has left the economy more dependent on a manufacturing and export boom for growth. Investors worry that this strong export run will suddenly slow after US President-elect Donald Trump takes office on January 20 with promises to impose tariffs of up to 60 percent on Chinese goods.
Citi economists estimated in a research note that a 15 percentage point increase in US tariffs would reduce China’s exports by 6 percent, knocking a percentage point off GDP growth. Growth in China was estimated at 5 percent last year.
More insidious than slower growth, however, are deflationary pressures on China’s economy, analysts said. 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 only in 1998-99,” they said, noting that only Japan, parts of Europe and some commodity producers had experienced such a long period of deflation.
Chinese regulators are aware of the parallels with Japan on deflation, said Robert Gilhooly, senior emerging markets economist at Abrdn, but “they don’t seem to be behaving like that, and one thing that contributed to Japan’s example was tapering with partial relief. “.
Goldman’s Shan said the central bank had promised to ease monetary policy this year, but just as important would be a large increase in China’s fiscal deficit at the central and local government levels.
How that deficit is spent will also be important. For example, channeling it directly to low-income households could have a higher “multiplier effect” than giving it to other sectors, such as banks for recapitalization, she said.
Frederic Neumann, chief Asia economist at HSBC, said another reason government bond yields were at record lows was that the economy was flush with liquidity. High household savings and low demand for corporate and individual credit have left banks flush with cash that is finding its way 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,” Neumann said. “Monetary easing at the margin is becoming less and less of an effective driver of economic growth.”
Without a strong fiscal spending package, the deflationary cycle could continue, with interest rates falling, wages and investment falling and consumers delaying purchases while waiting for prices to fall further.
“Some investors have lost a little bit of patience here over the past week,” he said, referring to the rush in bonds. “It is still possible that we will get more stimulus. But after all the fits and starts of the last two years, investors really want to see concrete numbers.”
Some economists warned that falling Chinese bond yields could see further declines. 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 needs to absorb higher net issuance of central government bonds for stimulus purposes. .
