The yield on the U.S. 10-year Treasury has been on an upward trajectory since June, reaching 4.7% this past Wednesday. This trend has significantly widened the yield differentials between Chinese and U.S. sovereign bonds, raising concerns about potential capital outflows and further pressure on the yuan. Meanwhile, Chinese commercial banks are turning to government bonds, as Beijing's stimulus efforts have yet to revive consumer loan demand.
In the 11 months leading up to November 2024, total new yuan loans fell by over 20%, amounting to 17.1 trillion yuan ($2.33 trillion) compared to the previous year. This decline highlights a broader slowdown in credit growth, influenced by stagnant mortgage demand and an economy that continues to falter despite stimulus interventions. Goldman Sachs forecasts a slowdown in China's economic growth to 4.5% this year.
As Chinese banks increase their purchases of government bonds, the People's Bank of China (PBOC) has halted its own bond buying due to excess demand and a short supply in the market. The new bank lending in November stood at 580 billion yuan, sharply down from 1.09 trillion yuan a year earlier. Economists at Standard Chartered Bank anticipate the bond rally will continue this year, albeit at a slower pace, with credit growth likely stabilizing by mid-year as stimulus policies start benefiting specific sectors.
"You have the perfect storm," said Sam Radwan, founder of Enhance International.
Chinese sovereign bonds have experienced a robust rally since December, with 10-year yields dropping to all-time lows this month. This bond market dynamic is partly a result of Beijing's inability to spur consumer credit demand through its stimulus measures. Andy Maynard of China Renaissance noted that bonds provide an "investable asset to put money in, both in financial market and in physical market," underscoring their appeal amid current economic uncertainties.
Zong Ke, a portfolio manager at Wequant, emphasized China's "efforts to prevent economic collapse and cushion against external shocks," highlighting the challenges facing policymakers. He added that these efforts are made "simply to avoid a freefall."
China's inflation rate remains subdued, with annual inflation in 2024 at just 0.2%, indicating minimal price growth. Additionally, wholesale prices fell by 2.2% over the same period. These figures reflect persistent deflationary pressures within the economy. The lackluster inflation environment further complicates efforts to reignite consumer spending and credit growth.
The widening yield spread between Chinese and U.S. bonds poses a risk of capital outflows as investors seek higher returns elsewhere. Lynn Song, chief economist at ING, referred to government bonds as "sources of risk-free yield," while expressing doubts about the strength of domestic policy support with "some question marks still remaining on how strong domestic policy support will be."
Despite these challenges, there is optimism that credit growth may stabilize by mid-year as stimulus measures begin to impact certain areas of the economy positively. However, mortgages, which historically drove credit demand, are still recovering from a period of stagnation. A key factor will be how quickly these sectors can rebound and contribute to broader economic stability.
Winson Phoon, head of fixed income research at Maybank Investment Banking Group, pointed out that foreign funds currently hold only a "small share" of investments in Chinese bonds, implying limited immediate impact from international market shifts.