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China’s government bond market has kicked off 2025, sending a clear warning to policymakers: Without more determined stimulus, investors expect deflationary pressures in the world’s second-largest economy will become more entrenched.
China’s 10-year government bond yield, a benchmark for economic growth and inflation expectations, fell to a record low of less than 1.6% in trading last week and has hovered near that level since.
Crucially, the entire yield curve has shifted downward rather than steepened, suggesting investors are spooked by the long-term outlook and not just anticipating short-term rate cuts.
“In the long run [bonds]yields have been trending downward, and I think that’s more because long-term growth expectations and inflation expectations have become more pessimistic. I think this trend is likely to continue,” said Shan Hui, chief China economist at Goldman Sachs.
The decline in yields contrasts with swings and rises in European and U.S. yields. The fall got off to a shady start for Beijing after policymakers launched a stimulus package in September aimed at reviving China’s economy.
But data released on Thursday showed consumer prices remained nearly flat in December, up just 0.1% from a year earlier, while factory prices fell 2.3% and have been in deflationary territory for more than two years.
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China’s central bank last year launched policies to stimulate institutional investment in the stock market and announced a “moderately loose” monetary policy for the first time since the 2008 financial crisis.
In December, a major economic conference chaired by President Xi Jinping emphasized consumption for the first time, rather than previously more important strategic priorities such as building high-tech industries.
The change in emphasis reflects concerns that household confidence has been eroded by a three-year housing crisis that has made growth more reliant on manufacturing and an export boom. Investors are worried that this strong round of exports will suddenly slow down after US President-elect Donald Trump took office on January 20 and promised to impose tariffs of up to 60% on Chinese goods.
Citi economists estimated in a research report that a 15 percentage point increase in U.S. tariffs would reduce China’s exports by 6%, thereby reducing GDP growth by one percentage point. China’s growth rate last year was expected to be 5%.
Analysts say, however, that more subtle than the slowdown in growth are deflationary pressures on the Chinese economy. Economists at Citi pointed out that in the last quarter of last year, the GDP deflator, a broad measure of price changes, was expected to be negative for the seventh consecutive quarter.
“This is unprecedented for China, with similar situations occurring 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. .
Robert Gilhooly, senior emerging markets economist at Abrdn, said Chinese regulators are aware of similarities with Japan on deflation, but “they don’t appear to be behaving in the same way as Japan, leading to the Japanese example.” One reason is to reduce the size of the economy through piecemeal easing.”
Shan Wei of Goldman Sachs said the central bank is committed to easing monetary policy this year, but equally important is the significant increase in fiscal deficits at both the central and local government levels in China.
How the deficit is spent also matters. For example, providing funds directly to low-income households may have a higher “multiplier effect” than providing it to other sectors, such as banks to recapitalize, she said.
Frederic Neumann, chief Asia economist at HSBC, said another reason for record-low government bond yields is ample liquidity in the economy. High household savings and low demand for business and personal loans have left banks flush with cash, which is making its way into bond markets.
“It’s a bit of a liquidity trap because there is money, it’s available, you can borrow it cheaply, but there’s just no demand,” Neumann said. “Marginal monetary easing is increasingly unable to be an effective driver of economic growth.”
Without a strong fiscal spending plan, the deflationary cycle is likely to persist, 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 their patience over the past week,” he said, referring to the rush for bonds. “It’s still possible that we’re going to have more stimulus. But after the ups and downs of the past few years, investors do want to see concrete numbers.
Some economists warn that the decline in Chinese bond yields could fall further. Analysts at Standard Chartered said the 10-year yield could fall another 0.2 percentage point to 1.4% by the end of 2025, especially if the market must absorb higher net issuance of central government bonds for stimulus purposes.
