China’s $11 trillion government bond market has moved into uncharted territory as a new era of monetary policy opens up debate over how much further yields will fall from record lows.
Bond prices soared after the country’s powerful Politburo made its strongest commitment to monetary easing in more than a decade. The yield on China’s 10-year bonds fell to a record low of 1.77%, while longer-tenor yields also tumbled.
Investors are now confronting the risk of what once seemed unthinkable: China’s 10-year bond yields sinking below those of Japan, which currently pay around 1.04%, and potentially sliding even further from there. Yields of zero remain a long way off but talk of that possibility has surfaced, showing how dramatically things have changed in China’s bond market.
“Bond yields at 0% are a possibility,” said George Boubouras, head of research at hedge fund K2 Asset Management Ltd. He said the central bank will need to take an ‘anything goes’ approach to stimulus to avoid the economy sliding into a Japan-style balance sheet recession.
Investors looking for a playbook can try to learn lessons from other examples of ultra-loose monetary policy, including periods of quantitative easing and near-zero rates in the U.S., Switzerland and the eurozone. But the most common comparison being made is to Japan, which suffered decades of tepid economic growth before adopting a negative interest rate policy in a last-ditch attempt to spur a rebound.
“The Japanification of China bonds may be inevitable at some point,” said Stephen Miller, a four-decade markets veteran and consultant at GSFM, calling the recent stimulus a sugar hit. “China’s issues are deep-seated structural issues. You can’t fully rule out the possibility of yields heading toward zero if these issues aren’t addressed,” he said.
Even more conservative estimates point to a sharp move lower in bond yields: Tianfeng Securities, Zheshang Securities and Standard Chartered Bank predict 10-year yields will drop to as low as 1.5%-1.6% by the end of next year. Wall Street banks are forecasting China’s biggest round of rate cuts in a decade, which would put further pressure on yields.
“It’s hard to discuss the level but what we care about is the trend, and the trend is for yields to go lower,” said Omar Slim, co-head of Asia fixed income at PineBridge Investments, adding that 1% yields were now a possibility for China’s 10-year bonds.
The pressure on yields underscores the stark shift in fortunes for China’s economy, which has struggled to recover from a real estate crunch, a slowdown in consumer spending and a prolonged period of near-zero inflation.
The recent move has capped a decline of around 0.78 percentage points in China’s 10-year bond yields this year, the biggest annual drop since 2015, according to Bloomberg-compiled data.
Regulatory risks
The comparisons with Japan are largely based on parallels with that country’s problems following a real estate crash in the 1990s: a hard-to-unwind debt bubble, an aging population, a reliance on loose monetary policy to turn things around. But there are crucial differences in the bond market, including how the central bank has used its balance sheet to influence yields.
The Bank of Japan for years used a policy of yield curve control to suppress bond returns, keeping yields on its 10-year bond close to zero. The People’s Bank of China has more often pushed yields in the other direction this year, selling bonds to force yields higher during periods of heavy buying. That has sent a mixed message to traders.
The PBOC is likely to cut rates three times next year and for now it is unlikely to see pushing back against bond buyers as a priority, said Lv Pin, chief fixed income analyst at Topsperity Securities Co. But yield curve control is probably not over, meaning investors should expect more interventions by the central bank next year, he said.
China’s 30-year bonds already pay less than those of Japan, after a decline of around 0.82 percentage points in China’s 30-year yield since the start of this year.
Just four years ago, investors were drawn to Chinese government bonds due to their clear pick up over developed markets. Now, 10-year U.S. Treasuries pay more than double the yield of their Chinese equivalent, after reaching their widest discount in more than two decades.
The Politburo’s monetary stimulus pledge this week called for a “moderately loose” policy approach in 2025. But that apparently cautious wording represented a key change for China’s monetary policy: The PBOC has this year cut benchmark rates, lowered reserve requirements and eased mortgage rules, all while the Politburo’s official guidance was for “prudent” policy.
The announcement came ahead of China’s Central Economic Work Conference, a gathering of senior politicians which led to further promises of stimulus next year as Beijing tries to head off the risk of U.S. tariffs. But despite the recent push, investors across the market still think more stimulus is needed—however much pressure it puts on bond yields.
K2 Asset Management’s Boubouras drew a comparison with former European Central Bank President Mario Draghi, whose pledge in 2012 to do “whatever it takes” to save the euro has become a shorthand for central bank determination.
“Beijing and the PBOC need to do a Mario Draghi exponentially,” Boubouras said. “It’s not only whatever it takes — it’s much more than whatever it takes.”
