Challenging The Narrative On The Chinese Bond Market
Bond Yields And Silver Linings
Since Chinese bond yields began dropping swiftly in early December, there has been a great deal of commentary on what this means for the Chinese economy. There have been more than a few viral social media posts claiming that this is concrete confirmation China is heading into a deep deflationary spiral.
China certainly has major issues with deflation. Between local government’s gradually running out of scope to pursue stimulatory fiscal policy and the base of Chinese prime age consumers declining by roughly 10 million people per year, fuel certainly exists for further deflation.
But when it comes to the moves of the Chinese bond market, there is more to it than concerns about the state of the Chinese economy and the future path of Chinese inflation.
Over the years Chinese investors in mainland markets have been on absolute rollercoaster ride, with it generally ending, shall we say sub-optimally.
Currently the Shanghai SSE 50 stock index (the largest 50 companies on the Shanghai stock exchange) sits at the same level as it was at in April 2007. Its a similar story for Hong Kong’s Hang Seng index, which is currently at the same level as November 2006 and only 4.8% above where it was in March of 2000.
The report card for other Chinese assets is generally also unimpressive. According to an analysis by KKR Global Macro, in H1 2024 the value of Chinese housing assets held by households has fallen by 37 trillion Yuan since 2021 (this may be a significant underestimation) . The value of household equity holdings fell by 16 trillion Yuan.
On the other hand, the value of cash and other deposits rose by 45 trillion Yuan and insurance based investment vehicles rose by 5 trillion Yuan.
So in just a few short years Chinese households have taken a hit worth 56 trillion Yuan ($7.7 trillion USD) on their net position in equity’s, housing and managed investment products (ex-bond and money market focused products).
While this analysis focuses on households, its indicative of the issue facing Chinese investors more generally.
Enter the realm of relative positivity for investors that is the Chinese government bond market. Since Chinese long bond yields hit their most recent major peak in 2020 and early 2021, the yield on the Chinese 10 year has fallen by up to 1.82 percentage points and by up to 2.22 percentage points on the 30 year.
So Chinese bond investors have enjoyed a relative bonanza of gains, while their compatriots in property and stocks have mostly been taken to the woodshed.
Its early 2025 and you’re a Chinese investor, retail or institutional, are you going to listen to the hype and roll the dice on property or stocks? Potentially getting burned again for what feels like 17th time. Or are you going to get into the bond market where gains have been on offer for most of the last four years?
In the words of economist Hong Hao:
“The recent plunge in bond yield is a reflection of depressed risk sentiment and buildup of excess savings. The Chinese is renowned to save the hardest in the world and now it’s Savin go even harder. Excess liquidity is not going into stocks, but instead going into bonds and WMPs (Wealth Management Products) that mostly invest in bonds.”
But there is something of a silver lining amidst the ongoing falls in Chinese bond yields, borrowing costs even for the likes of troubled local governments are plummeting.
As Beijing seeks to reduce the burden of debt servicing for local governments, lower bond yields provide a unique opportunity, particularly for local government looking to take local government financing vehicle debts on to their balance sheets.
Based on the spread between central government bonds of the same duration and issuance data from the Chinese Ministry of Finance, local governments are at tines only paying as little as 5-10 basis points (0.05 to 0.1 percentage points) more on their newly minted bonds than the central government.
In October, the average yield on a newly minted Chinese local government 10 year bond was just 2.22%. Considering local government financing vehicle yields were well north of 4% in 2023 and older longer duration maturities were even higher again, being able to roll over debt so cheaply is helping local governments to keep the plates spinning.
Ultimately, the Chinese government is likely to see the fall in bond yields as a positive development in a vacuum. While the underlying reasoning is hardly welcome, it helps to provide them with the most precious resource of all given their position, time.
Up next at Burnout Economics in the coming weeks for paid subscribers, China’s age demographics vs Japan and South Korea, looking at the issue from the perspective from prime age consumers to the next incoming cohort of that nation’s young. As always there will be something in it for all subscribers.
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What you say makes a lot of sense.
A golden opportunity to convert short to long term debt at low interest rates. Makes China a capital rich country. Was this what Keating was forcing via the superannuation provisions? How many local governments in Australia can borrow at 2%?
Unless this money goes into infrastructure that makes economic sense it will be an opportunity wasted.
Some no doubt goes into the Belt and Road initiative.
Some goes into education.
Some goes into R and D.
Some could go into improving the lot of rural China that is already helped by the rail and road network because it opens up the market.
Cheap transport opens up tourism.
Cheap transport facilitates door to door delivery and people with phones and modes of electronic payment that are free of rake offs, stimulates on line purchasing.
Makes China an economic powerhouse.
With attitude: Open Source tech rather than the subscription model.
Hopefully next an open source provider to displace Microsoft.