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China’s government bond market opened 2025 with a clear warning to policymakers: Without more decisive 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 expected inflation, fell to a record low level less than 1.6 percent during trading last week and has been hovering near that level since then.
Crucially, the entire yield curve has shifted downward rather than steeper, suggesting that investors are concerned about the long-term outlook rather than just anticipating short-term interest rate cuts.
“In the long term [bonds]yields have been going down and I think it’s more about longer-term growth expectations and inflation expectations becoming more pessimistic. And I think that trend is likely to continue,” said Hui Shan, chief China economist at Goldman Sachs.
Falling yields are in 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 an incentive drive designed to revive the animal spirit of the Chinese economy.
But data released Thursday showed 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 deflationary territory for more than two years.
China’s central bank unveiled policies to encourage institutional investment in stock markets last year and announced for the first time since the 2008 financial crisis that it is adopting “moderately loose” monetary policy.
An important meeting of the Communist Party on the economy in December, chaired by President Xi Jinping, consumption emphasized for the first time over other previously more important strategic priorities such as the construction of high-tech industries.
The shift in emphasis reflects concerns about household sentiment weakened by a three-year property crisis that has left the economy more dependent on manufacturing and export growth. Investors are worried about this series strong exports will slow down sharply 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 estimate in a research note that a 15 percentage point increase in US tariffs would reduce Chinese 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 in China’s economy, analysts say. Citi economists noted that the final quarter of last year is expected to be the seventh in a row in which the GDP deflator, a broad measure of price changes, has been 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 have experienced such a prolonged period of deflation.
China’s regulators are aware of the parallels with Japan in terms of deflation, said Robert Gilhooly, senior emerging markets economist at Aberdeen, but “they don’t seem to be acting that way, and one thing that contributed to Japan’s example was tapering with gradual easing.” .
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.
It will also be important how that deficit is spent. Targeting low-income households directly, for example, could have a greater “multiplier effect” than giving to other sectors, such as recapitalization banks, she said.
Frederic Neumann, chief Asia economist at HSBC, said another reason government bond yields are at record lows is that the economy is awash in liquidity. High household savings and low demand for corporate and individual loans have left banks awash with cash finding its way into the bond market.
“It’s a bit of a liquidity trap in the sense that the money is there, 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 a less and less effective driver of economic growth.”
Without a strong fiscal spending package, the deflationary cycle could continue, with falling interest rates, falling wages and investment, and consumers delaying purchases while waiting for further price falls.
“Some investors lost a little bit of patience here last week,” he said, referring to the bond rush. “It is still likely that we will get more stimulus. But after all the head-scratching of the past few years, investors really want to see concrete numbers.”
Some economists have warned that the fall in Chinese bond yields could fall further. Analysts at Standard Chartered said the 10-year yield could fall a further 0.2 percentage points to 1.4 percent by the end of 2025, particularly if the market has to absorb more net issuance of central government bonds for stimulus purposes.
