China’s 10-year bond yield has recently dropped below 1.6 percent, a consequence of a weakening economy plagued by deflation. For the first time in 14 years, restrictive monetary policy has shifted towards a moderately expansionary stance. The goal: to support the economy and repair reputational damage.
China is facing turbulent times. Once a flawless example of how emerging nations could lift themselves out of poverty, the country’s economic growth has now slowed, and the ongoing property crisis has left deep scars. Chinese consumers are holding back on spending, domestic businesses are demanding less credit, and risk-averse Chinese investors are parking their money in bonds.
The result is a deflationary environment, which the central bank is attempting to combat with lower interest rates and rate cuts. The hope is that this will revive domestic consumption.
Over the past five years, the 10-year bond yield has fallen from 2.6 percent to 1.6 percent today. During the same period, the 30-year bond yield has dropped from 3.7 percent to 1.8 percent. “In November 2024, China’s 30-year bond yield fell below Japan’s 30-year yield. This aligns with the widely discussed expectation that China is heading towards ‘Japanification’,” said Lodewijk van der Kroft of Comgest. He refers to a prolonged period of low economic growth, low inflation, and extremely low interest rates, similar to Japan’s experience since the 1990s.
30-year government bond yields: China vs Japan
The Chinese government is prepared to go even further than the central bank, explains Wei He from Gavekal. “Civil servants are receiving salary increases, and certain goods are being subsidised. While the Chinese population could hardly count on government support during the pandemic, the government is now showing a willingness to intervene.”
A weakening economy
Just five years ago, the Chinese economy seemed invincible, boasting stable growth figures that developed countries could only dream of. “China has achieved impressive growth over recent decades. Now, it is encountering the middle-income trap, the point where the government must hand over the baton to businesses and consumers. That process is proving difficult,” says Van der Kroft.
He adds that the problems in the Chinese economy are structural in nature and that credit demand is primarily driven by state-owned enterprises. “These companies tend to keep producing to stimulate economic growth, even when this leads to overproduction.”
The country is also grappling with high youth unemployment. “There are fewer jobs available for young people, yet many of them only aspire to the most prestigious positions, even as blue-collar jobs are offering increasingly better pay,” says He.
Risk-off mentality
A genuine risk-off mentality appears to have taken hold among the Chinese population. Following the property crisis, many Chinese citizens have lost their appetite for risk. Van der Kroft explains: “In China, you have to arrange your own retirement savings. Many Chinese people viewed property as the safest place to park their savings, but the property crisis has been a harsh lesson.”
There are currently few places where Chinese citizens feel confident about storing their savings. According to He, savings held in deposits are increasing. “Bonds are in demand and delivered a respectable performance of 9 percent last year, thanks to falling interest rates,” Van der Kroft adds.
Reputational damage to equities
China, long the heavyweight economy in emerging markets, has seen its share of the MSCI Emerging Markets Index decline from nearly 40 percent to 27.8 percent. At the end of August, India temporarily surpassed China in the MSCI All Country World Investable Market Index (ACWI IMI). However, Chinese stock markets staged a strong rally in September, regaining their position.
Yet, the first week of the new year saw Chinese stock markets post negative figures. The CSI 300 Index, the benchmark for mainland Chinese equities, lost 3.4 percent. Small-cap stocks, represented in the CSI 2000 Index, fared even worse, dropping 7 percent.
Van der Kroft notes that heightened geopolitical risks are making investors hesitant to invest in China. The close ties with Russia serve as a reminder to emerging market investors of the risks of capital flight, particularly in light of a potential invasion of Taiwan. Moreover, the United States is actively discouraging investments in China, further compounding the country’s economic pressure.