Chinese Bond Markets Under Pressure: New Record Lows in Yields Expected

Chinese bond investors are driving yields towards new lows as they factor in a grim outlook for economic growth and disregard the central bank's efforts to curb the rally in long-term debt securities. The yield on China's ten-year benchmark government bond is expected to close at a record low on Thursday, while the 30-year yield fell to its lowest level in nearly two decades. These developments follow a wave of growth forecast cuts for China by global banks and come as authorities consider mortgage rate cuts to alleviate a four-year-long real estate crisis. The People's Bank of China (PBOC) conducted long-term bond sales and short-term bond purchases last month to contain the rally at the long end of the yield curve. However, this measure was partly undermined by strong demand for Chinese bonds from local investors and rising expectations of interest rate cuts. Experts, such as Zhaopeng Xing, senior strategist at Australia & New Zealand Banking Group, see increasing chances for an interest rate cut in China, similar to the expected move by the Federal Reserve in September. He anticipates that the central bank will defer its measures to control the yield curve due to the urgent need for economic support. Rising bets on PBOC interest rate cuts have pushed five-year domestic interest rate swap rates, a measure of banks' expectations for borrowing costs, to their lowest level since 2009. Analysts criticize the PBOC's conflicting goals of stimulating the economy while curbing a bond rally, arguing that such measures could cancel each other out. Nevertheless, the PBOC's interventions have had some effect. Shorter-term bonds led the rally this week and widened the yield gap between three- and ten-year bonds on Wednesday to the largest difference since 2020. Goldman Sachs described the PBOC's measures as the "Chinese style of yield curve control." Despite the central bank's actions to raise the minimum yield for long-term government bonds, weak domestic demand and poor sentiment could drive yields further down in the medium term. The yield on the ten-year Chinese bond fell to 2.1160% on Thursday, and a closing below the August 2 low of 2.1277% would be the lowest ever recorded, according to ChinaBond data. Steven Major, global head of fixed income research at HSBC, stated in a note: "While the central bank, as widely expected, sells long-term bonds, the economic forces and the direction of the policy rate are most important for bond yields." He predicts that China's ten-year yield could fall to 2% by the end of the year and to 1.8% by the end of 2025.