China’s bond market has hit a turning point, with long-term sovereign bond yields falling below Japan’s for the first time. This trend signals deep concerns about deflation and economic stagnation, akin to Japan's struggles in the 1990s. Here’s what’s happening and what it means.

Chinese Yields Drop Below Japan’s

Chinese 30-year government bond yields have plummeted from 4% in 2020 to 2.24% in November 2024, driven by:

• Lower interest rates: Beijing is cutting rates to revive economic growth.
• Investor caution: Chinese investors are retreating to safe assets amidst economic uncertainty.

In contrast, Japan’s bond yields have risen to 2.31%, reflecting its efforts to exit deflation and normalise monetary policy.

Deflation Grips the Chinese Economy

Deflationary pressures are entrenched in China, mirroring Japan’s post-bubble economy in the 1990s. Key indicators include:

• Minimal inflation: China’s core inflation (excluding food and fuel) stood at just 0.2% annually in October.
• Weak consumer demand: Despite monetary and fiscal stimulus, domestic demand remains sluggish.

Experts believe these factors will keep Chinese bond yields low for the foreseeable future.

Policy Challenges for Beijing

The Chinese government is trying to tackle these issues with bold measures:

• Interventions in bond markets: Authorities have taken steps to push up longer-term bond yields and warned banks about the risks of a debt bubble.
• Economic diversification: Investments in high-tech, green energy, and electric vehicles aim to create sustainable growth.

However, analysts argue these efforts may not be enough. Goldman Sachs noted policymakers’ concern that low bond yields reflect pessimistic growth and inflation expectations.

Lessons from Japan’s Lost Decades

The parallels with Japan are striking. Following a property market crash in the 1990s, Japan faced decades of economic stagnation. Similar conditions in China, such as an oversupplied property market and a reliance on stimulus, raise alarms among investors.

“Nineties Japan remains the playbook,” said Zhenbo Hou, a sovereign strategist at RBC BlueBay Asset Management.

Future Outlook: What Needs to Change?

For China to escape the deflation trap, significant policy shifts are needed:

• Boosting consumption: Encouraging household spending is key to driving demand.
• Reducing overinvestment: Addressing excess capacity in industries is critical to balancing the economy.

Without these changes, deflation and low yields may persist, limiting economic growth.

Conclusion: A Crossroads for China’s Economy

China’s bond market struggles underscore broader economic challenges. While interventions and sector investments may help in the short term, only a major policy shift focusing on domestic consumption and structural reform can chart a path away from deflation and stagnation.

Source: (FT.com)