China’s Bond Market Hits Historic Low as 10-Year Yield Falls Below 2%

China’s 10-year government bond yield fell below 2% on Monday, reaching a historic low of 1.975%. This milestone highlights the impact of a sluggish economy, sustained investor demand for bonds, and expectations of further rate cuts by the People’s Bank of China (PBOC). The decline in yield reflects the growing appeal of safer assets amid China’s economic uncertainties.

Key Drivers of the Rally

The decade-long rally in China’s bond market accelerated over the past two years due to several factors:

1. Economic Slowdown: Weak growth, particularly in the property sector, has dampened risk appetite.
2. Low Deposit Rates: The recent ban on offering preferential deposit rates underscores the low-rate environment.
3. Investor Appetite: Funds and institutions remain under-allocated to bonds, prompting increased purchases, especially by insurance companies anticipating allocations ahead of the new year.

Morgan Stanley analysts predict continued bond market strength, citing expectations of a 40 basis point (bps) cut in China’s policy rate by the end of Q1 2024.

Comparative Yield Dynamics

China’s bond yields now significantly trail those of U.S. Treasuries. The 10-year Chinese bond offers 222 bps less than its U.S. counterpart, marking the largest gap since the early 2000s. This inversion reflects China’s weaker economic performance compared to the U.S. post-pandemic.

Additionally, China’s 30-year bond yield fell 4 bps to 2.16%, while 10-year treasury futures, which move inversely to yields, rose 0.4% to a record closing high.

PBOC Measures and Policy Impact

The PBOC has implemented policies aimed at reducing rates, including:

• Aligning deposit rates for non-bank institutions with the 7-day reverse repo rate of 1.5%.
• Injecting liquidity into the market, such as 800 billion yuan in 3-month reverse repos in November.

These measures lower short-term rates and contribute to the downward trend in long-term yields. For instance, one-year AAA-rated negotiable certificates of deposit (NCDs) fell 10 bps on Monday to below 1.7%.

Outlook for 2024

Analysts expect China’s 10-year yield to decline further, potentially reaching the 1.7%-1.9% range next year. Loose monetary policy and supportive funding conditions will likely sustain the bond rally.

Implications

While the bond market’s performance signals robust investor confidence in fixed-income securities, it also reflects deeper concerns about China’s economic trajectory. Policies aimed at preventing a hard landing may keep yields low, but the challenges of spurring growth remain.