China’s government bond market has opened 2025 with a clear warning for policymakers: without more determined 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 per cent during trading last week and has since hovered close to that level.
Crucially, the whole yield curve has shifted downwards rather than steepening, suggesting investors are alarmed about the long-term outlook and not just anticipating short-term cuts to interest rates.
“For the long-term [bonds], yields have been trending down and I think that’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 offer a stark contrast to volatile and rising yields in Europe and the US. For Beijing, the fall represents an ignominious start to the year after policymakers in September launched a stimulus drive designed to revive the Chinese economy’s animal spirits.
But data released on Thursday showed consumer prices remained close to flat in December, eking out growth of just 0.1 per cent on a year earlier, while factory prices declined 2.3 per cent, remaining in deflationary territory for more than two years.
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China’s central bank last year unveiled policies to stimulate investment by institutions in equity 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 “shortage of supply” meant it would pause its programme that has seen it purchase a net Rmb1tn of government bonds on the open market.
An important Communist party meeting on the economy in December, presided over by President Xi Jinping, emphasised consumption for the first time over other previously more important strategic priorities such as building high-tech industries.
The change of 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 this run of strong exports will slow abruptly after US president-elect Donald Trump takes office on January 20 with promises to levy up to 60 per cent tariffs 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 per cent, knocking a percentage point off GDP growth. Growth in China was estimated to be 5 per cent last year.
More insidious than the slower growth, however, are the deflationary pressures in China’s economy, said analysts. The 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, pointing out that only Japan, parts of Europe and some commodity producers had experienced such an extended 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 like it, and one thing that contributed to the Japan example was going small with piecemeal 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.
How that deficit is spent will also be important. Channelling it directly to low-income households, for example, might have a higher “multiplier effect” than giving it to other sectors, such as to banks for recapitalisation, she said.
Frederic Neumann, chief Asia economist at HSBC, said another reason government bond yields were at record lows was that the economy was awash with liquidity. High household savings and low demand for corporate and individual loans have left banks flush with cash that is finding its way into bond markets.
“It’s a little bit of a liquidity trap in the sense that there is money, it is available, it can be borrowed cheaply, but there’s just no demand for that,” said Neumann. “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 might continue, with interest rates dropping, wages and investment falling and consumers deferring purchases while they wait for prices to fall further.
“Some investors have lost a little bit of patience here in the past week,” he said, referring to the rush into bonds. “It’s still likely we’re going to get more stimulus coming through. But after all the fits and starts of the past couple of years, investors really want to see concrete numbers.”
Some economists warned that the slide in Chinese bond yields could have further to fall. Analysts at Standard Chartered said the 10-year yield could fall another 0.2 percentage points to 1.4 per cent by the end of 2025, especially if the market has to absorb higher net central government bond issuance for stimulus purposes.
