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China’s bond market is sending alarm signals over the state of the economy, as its central bank uses financial heft and brash warnings to battle deflationary pressures.
The country’s benchmark 10-year sovereign yield has fallen from more than 2.5 per cent at the start of last January to about 1.6 per cent at the beginning of 2025, sparking warnings of “Japanification”, in which the economy suffers a protracted period of deflation and sluggishness.
The People’s Bank of China has repeatedly expressed concern over regional banks buying up its government bonds in the past year, and sending the country’s borrowing costs plunging — in a mirror image of what has happened in western debt markets over the past months.
In a statement in April, the PBoC warned that China risked Silicon Valley Bank-style bank runs if its financial sector continued to purchase long-dated sovereign bonds.
Then, in August, the bank named and shamed four rural commercial banks for “manipulating sovereign bond prices in the secondary market” — a move that was seen as a warning to other banks. At the same time, people close to the central bank told the Financial Times that its plans to issue billions of dollars of fresh government debt and special bonds threatened to burst a bubble that it said had formed in the market.
This month, the PBoC won a rare reprieve from the market after it announced it would cease its programme of treasury purchases indefinitely after five months. During that time, the central bank had bought a net $1tn worth of bonds, sending yields up slightly.
But analysts say the risk of a systemic financial event stemming from this purchasing Chinese government bonds is low, given the lack of parallels with Silicon Valley Bank. In 2023, SAB had put an abnormally large proportion of its assets into US Treasury bonds without hedging the interest rate exposure.
It was one of several US banks left sitting on big paper losses as the long-dated bonds they had bought and held without interest rate hedges fell in price, after the US Federal Reserve raised rates more than 5 per cent between 2022 and 2023. Bond yields move inversely to prices. This triggered a crisis as SVB’s depositors — principally start-ups — were sophisticated clients with a need for cash.
I think the concern over something similar to SVB should not be too high because, in China, the regulator and the government are always very proactive in stepping in to provide support to financial institutions,” explains May Yan, head of Asia financials at UBS investment bank. “They wouldn’t wait for days for a bank run to occur.
“A bank run could happen at any time or, if you overinvest in low-rate assets, it becomes problematic when the central bank hikes rates rapidly,” Yan notes. “However, no one anticipates such a swift rate increase in China any time soon.”
The other concern raised by Chinese authorities — that a massive bond issuance, as may be necessary for the government to launch a fiscal stimulus, could lead to a spike in yields — has also been dismissed by some economists.
“A huge amount of bond issuance will only be done if it mirrors a weak economy due to too high private savings,” says Allan von Mehren, chief China economist at Danske Bank. “Those savings need a home and bonds would be one of them — as is the case today.”
Von Mehren adds that, even in the case of a stronger economy, in which investors switch from bonds to equities, a big move downwards in bond prices would most likely be met with intervention from authorities “to stabilise markets in that case”.
Global investors have largely brushed off the warnings from the PBoC and continued to hold Chinese government bonds as an investment, believing that their prices will rise more, sending yields further down.
“Chinese bonds were among the standout performers in local emerging markets in 2024, rewarding holders with falling yields despite rising yields globally,” points out Marcelo Assalin, head of William Blair Investment Management’s emerging markets debt team. There is still a case for Chinese bond yields to fall further given attractive real yields in higher duration bonds, the disinflationary path, and concerns around the potential for deflation.”
Mark Evans, emerging markets fixed income portfolio manager at asset manager Ninety One, is also a holder. He says: “We have been overweight for some time and remain overweight”. In his view, “real rates remain attractive” and bond prices have continued to rise despite an increased expectation of issuance to come.
But investors reject the idea that China’s sovereign bond yields could decline all the way to 0 per cent, as Japan experienced in the past decade, cementing the risks of stagnant growth and deflationary pressures.
“We expect Chinese government stimulus to be more aggressive and more effective in 2025, placing a floor on what are already low levels of yield on an absolute level,” says Assalin.
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