China’s Falling Bond Yields Raise Alarm Over Deflation

Concerns Over Deflation Deepen

China’s bond market has begun 2025 with troubling signals for policymakers. Falling government bond yields, including a record low of under 1.6% for 10-year bonds, highlight investor fears that deflationary pressures are becoming deeply entrenched in the world’s second-largest economy. Unlike short-term rate cuts, the downward shift in the entire yield curve suggests long-term pessimism about growth and inflation.

Economic Data Reflects Deflationary Trends

Recent economic data underscores these concerns:

• Consumer Prices: December saw minimal growth of just 0.1% compared to the previous year.
• Factory Prices: A 2.3% decline marked over two years of deflationary trends in industrial production.
• GDP Deflator: Analysts expect the GDP deflator to remain negative for a seventh consecutive quarter, an unprecedented scenario for China since the late 1990s.

Challenges for Policymakers

In response to these challenges, Beijing has shifted its focus towards stimulating consumption, moving away from priorities such as high-tech industries. Despite these efforts, lingering issues such as a three-year property crisis and weakening household sentiment are limiting growth. Economists estimate that China’s growth was around 5% last year, but ongoing deflation threatens to reduce that further.

Liquidity Trap Worsens Economic Strains

China’s economy faces a liquidity trap, characterised by high household savings and low loan demand. While banks are flush with cash, this excess liquidity is primarily flowing into bond markets rather than driving economic growth. “There is money available and it can be borrowed cheaply, but there’s just no demand for it,” said Frederic Neumann, Chief Asia Economist at HSBC.

The Need for Fiscal Stimulus

Experts agree that monetary easing alone is insufficient to combat deflation. Analysts emphasise the importance of robust fiscal spending to break the cycle of falling prices, wages, and investment. Hui Shan, Chief China Economist at Goldman Sachs, suggests targeting fiscal spending towards low-income households to maximise its multiplier effect.

Robert Gilhooly of Abrdn noted parallels between China’s current predicament and Japan’s prolonged deflation in the late 20th century. “Chinese regulators recognise the risks but seem hesitant to adopt large-scale measures,” he said.

Investor Patience Wears Thin

The bond market’s current trajectory is troubling, with some investors anticipating yields on 10-year bonds to fall further, potentially reaching 1.4% by the end of 2025. As expectations for significant fiscal action rise, investors are calling for concrete and decisive measures to stabilise the economy.

Conclusion

China’s falling bond yields serve as a stark warning of entrenched deflationary pressures. Without substantial fiscal intervention and efforts to boost consumption, the deflationary cycle risks deepening, jeopardising long-term economic stability. As policymakers navigate these challenges, decisive action will be critical to restoring investor confidence and sustaining growth.

Source: (FT.com)