Investors in Chinese bonds are heading into 2025 with tempered expectations for an economic recovery, a stance that sharply contrasts with the equities market’s bullish bet on a revival in consumer spending.
While China’s closed capital account limits its bond market’s predictive value as an economic barometer, the record lows in ten-year bond yields and long bonds dipping below Japan’s levels indicate persistent skepticism about the nation’s growth prospects.
“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 at UBS Investment Bank.
Bond Market Reflects Slow Growth and Low Inflation
The benchmark ten-year bond yield, down over 80 basis points this year to a record low of 1.78%, mirrors a banking system awash with cash and expectations of muted growth and inflation. The 30-year yield has dropped below 2%, even lower than Japan’s 30-year yield of 2.24%, reflecting deep-seated pessimism about China’s long-term economic trajectory.
“We think it’s difficult to see meaningful inflation given the property situation in China now and the government’s determination not to create another property bubble,” said Edmund Goh, investment director of fixed income at abrdn in Singapore.
Equities Rally Amid Policy Promises
Since September, China’s interest rate cuts and promises to stabilize financial and property markets have driven a rally in equity markets, pushing price-to-earnings ratios higher. However, bonds have moved in the opposite direction, underscoring a lack of confidence in sustained earnings or reflation driving the equity surge.
Goldman Sachs forecasts China’s growth to slow to 4.5% in 2025, down from the government’s 2024 growth target of “around 5%.”
Abundant Liquidity Supports Bond Rally
A glut of liquidity in China’s banking system is a major factor behind the bond rally. With over 300 trillion yuan in deposits and weak credit demand, banks are channeling excess funds into money markets and bonds, driving yields lower.
“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.
The popular Tianhong Yu’Ebao money fund hit a record low yield of 1.266% this week, highlighting the limited investment alternatives.
Risks and Opportunities in the Bond Market
Potential risks to the bond rally include the possibility of a large fiscal stimulus package from Beijing, which could necessitate additional borrowing and drive up inflation. The People’s Bank of China has also intervened by selling bonds to temper the rally, while foreign investors like BlackRock have taken profits after the extended rally.
Still, many investors remain optimistic about Chinese bonds. Analysts at Shoupu Asset Management expect the ten-year yield to fall to 1.6% in 2025, citing weak economic fundamentals and limited policy measures to stabilize growth.
“We’re struggling to find much reason to be pessimistic about the sovereign bond market,” said Shoupu analysts in a November letter to investors.
