China's bond market signals economic pessimism

Taipei [Taiwan], December 17 : China's bond market is signalling growing concerns about the country's economic recovery, with analysts noting record-low bond yields and a widening gap compared to other economies, such as Japan. Investors are betting that there will be no quick recovery, even as the equities market seems to be rallying based on expectations of a rebound in consumption,as reported by Taipei Times.
Despite the closed nature of China's capital account limiting the broader economic forecasting value of the country's massive 33 trillion yuan bond market, the persistent negativity reflected in its bond yields is undeniable.
The benchmark 10-year bond yield in China has dropped more than 80 basis points this year, reaching a record low of 1.78 per cent. This suggests a banking system flush with cash and widespread expectations for slow growth, accompanied by low inflation.
"The bonds are basically saying that, yes, there is a [stock market] rally out there, but we don't buy this rally for the long term," said Bhanu Baweja, Chief Strategist for UBS Investment Bank in London. He further added, "Bonds are saying that this is not an earnings-based rally, this is not a reflation-based rally." This stark contrast between the bond market's pessimism and the bullish mood in equities highlights a fundamental divide in investor outlooks for China's economy.
While China's bond market continues to face challenges, including the long-term downward pressure on yields, the equity markets have seen growth, in part fuelled by government assurances of economic support. Since September, as China has cut interest rates and made efforts to stabilise its financial and property markets, equities have rallied, driving up price-to-earnings ratios. This has driven up optimism in some quarters, but the bond market's more cautious stance reflects scepticism about a sustainable recovery, reported Taipei Times.
"The Chinese bond yields should be lower if they were to reflect the current economic situation in the country," said Edmund Goh, Investment Director of Fixed Income at ABRDN in Singapore. According to Goh, China's property market woes and the government's determination not to create another property bubble make meaningful inflation unlikely in the near future, which continues to weigh on bond yields.
Meanwhile, the economy's overall sluggishness is reflected in slower-than-expected growth, with China reporting just 4.6 per cent growth in the third quarter of 2024, a figure far below the government's initial target of 5 per cent for the year.
At the same time, the bond market continues to face pressure from a lack of alternative investment options. With Chinese banks holding more than 300 trillion yuan in deposits and with loan growth stagnating, much of this capital has flowed into money markets and government bonds, further pushing down yields.
"Onshore lenders are facing the question of whether to give out loans to businesses or to play it safe with risk-free Chinese government bonds," said Clarissa Teng, Fixed Income Allocation Strategist at UBS Global Wealth Management in Hong Kong. "Many are doing the latter, especially given that credit demand from households and corporates has been soft as well."
Although some risks remain, such as a potential fiscal spending boost or higher inflation, analysts continue to predict that the bond market's downward trajectory will persist unless significant policy changes are implemented.
"We're struggling to find much reason to be pessimistic about the sovereign bond market," stated analysts at Shanghai-based Shoupu Asset Management in a recent letter to investors. They added, "The facts of economic fundamentals are out there, and without strong, targeted growth-stabilising policies, there is little resistance to the decline in bond yields."
As China's central bank continues to intervene in the bond market by selling bonds to slow the rally, foreign investors, including BlackRock, have also reduced their exposure, taking profits after the prolonged bond rally, Taipei Times reported.
Still, some investors, like Li Kai, Chief Investment Officer of Beijing Shengao Fund Management, remain optimistic, forecasting a 10-year yield of 1.6 per cent for the next year.
Ultimately, as the Chinese government attempts to revive growth and stabilise its economy, the bond market's subdued outlook will continue to weigh on expectations for the country's economic recovery.