Plunging yields on Chinese bonds are a symptom of economic weakness. Since last November, yields on China’s 10-year bonds have fallen from 2.75% to 2.15%. This is a worrying sign that all is not well in the Chinese economy, and that further slowing is anticipated. As China is Australia’s largest trading partner, this will no doubt have negative implications for the Australian economy – and especially for our large commodity exports such as iron ore.
While it is common for central banks around the globe to meddle in their bond markets, it is rarer for them to intervene to push yields up. Yet this appears to be what China’s central bank is doing – the authorities have gone to some lengths to try to stem the rally in the bonds they issue.
The official explanation is that banks could end up with huge losses if the bond rally takes a sharp turn, citing Silicon Valley Bank in the US as an example. That bank faced a devastating run last year as depositors were spooked by unrealised losses it had on its balance sheet from US Treasury bonds bought before the Federal Reserve began rapidly raising interest rates.
There have been signs of speculative activity in Chinese government bonds. Trading volume has surged, and some price action has been getting irrational: one 30-year government bond issued in May traded up 25% on the first day, very unusual for a (supposed-to-be) boring government-bond market.
But there are strong fundamental reasons why investors are flocking to the low-yielding assets. First, China’s economy remains caught up in weakness, dragged down by the collapse of its housing market. Instead of worrying about inflation, an issue in the US and most of the rest of the world, deflation is the problem instead. China’s core consumer price index, which excludes food and energy, rose only 0.4% year on year in July, down from 0.6% in June.
There is a lack of attractive investment alternatives in China at present. China’s CSI 300 index, which tracks the biggest stocks listed in Shanghai and Shenzhen, is down 3% this year after 3 consecutive years of losses. The property market, which used to be the most popular form of investment for Chinese households, remains in recession. New home prices in 70 major cities dropped 5.3% in July from a year earlier.
Beijing is not so much worried about low yields on bonds as it is concerning what that says about the Chinese economy. That instead of lending money out, banks are happier to let it sit in government bonds with ever-lower yields. In a country that can stamp out unpleasant news such as economic pessimism in the news media and the internet, bond yields are a sign of trouble that can’t be censored. Like when the authorities stopped reporting on the high rate of youth unemployment once it rose above 20%.
Declining bond yields are a sign of economic weakness, and a lack of confidence and growth opportunities. For bond yields to go sustainably higher, Beijing needs to go beyond treating the symptoms and deal with what is clouding the economy: fixing the housing market, boosting consumption and restoring investment confidence.
China 10 Yr Government Bond Yield
Source: Trading Economics
