Falling Chinese bond yields signal deflation concerns

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China’s government bond market opened 2025 with a clear warning for policymakers: without more decisive economic stimulus, investors expect deflationary pressures to become even more entrenched in the world’s second-largest economy.

China’s 10-year bond yield, a measure of economic growth and inflation expectations, fell to a record low During trading last week, the price was less than 1.6 percent and has since settled near that level.

Crucially, the entire yield curve has shifted downward rather than steepening, suggesting investors are concerned about the long-term outlook rather than just expecting short-term rate cuts.

“In the long term (bonds) yields are trending lower and I think that’s more because longer-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 US. For Beijing, the fall represents an ignominious start to the year, according to policymakers in September launched an economic stimulus initiative Designed to revive the spirit of China’s economy.

However, data released on Thursday showed that consumer prices remained almost unchanged in December, growing just 0.1 percent year-on-year, while factory prices fell 2.3 percent and remained in deflationary territory for more than two years.

China’s central bank unveiled measures to stimulate institutional investment in stock markets last year, the first time it said it would introduce one since the 2008 financial crisis “moderately loose” monetary policy.

A key Communist Party meeting on the economy in December chaired by President Xi Jinping, For the first time, the focus was on consumption compared to other previously more important strategic priorities such as the development of high-tech industries.

The shift in focus reflects concerns about household sentiment, weakened by a three-year housing crisis that has left the economy more reliant on a manufacturing and export boom for growth. Investors are worried about this Strong exports will slow abruptly after US President-elect Donald Trump takes office on January 20 and 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 U.S. tariffs would reduce China’s exports by 6 percent and shave one percentage point off GDP growth. Growth in China was estimated at 5 percent last year.

More insidious than the slower growth, however, is the deflationary pressure in the Chinese economy, analysts said. Citi economists noted that the final quarter of last year was expected to be the seventh straight in which the GDP deflator, a broad measure of price changes, was negative.

“This is unprecedented for China; a similar episode occurred as recently as 1998-99,” they said, pointing out 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 act that way, and one thing that Japan’s example has contributed to has been gradualism.” Relaxation”.

Goldman’s Shan said the central bank had promised to ease monetary policy this year, but just as important would be a sharp increase in China’s budget deficit at the central and local government levels.

How this deficit is spent will also be important. For example, passing it directly to low-income households could have a larger “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 are at record lows is that the economy is flooded with liquidity. High household savings and low demand for business and personal loans have left banks flooded with cash finding its way into bond markets.

“It’s a bit of a liquidity trap in the sense that money is there, available and can be borrowed cheaply, but there’s just no demand for it,” Neumann said. “Monetary policy easing at the margins is becoming less and less an effective driver of economic growth.”

Without a strong stimulus package, the deflationary cycle could continue, with falling interest rates, falling wages and investment, and consumers putting off purchases while they wait for further price declines.

“Some investors have lost a bit of patience here in the last week,” he said, referring to the rush on bonds. “It is still likely that we will receive further economic stimulus. But after all the back and forth over the last few years, investors are desperate to see concrete numbers.”

Some economists warned that the decline in Chinese bond yields could fall even 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, particularly if the market has to absorb higher net issuance of government bonds for stimulus purposes.