China's sovereign bonds soar as shaky economic growth outlook dampens risk appetite

A powerful rally in China's government bonds that has pushed yields to a two-decade low shows no signs of easing amid persistent worries about the outlook for growth. A sluggish stock market and a long-running property downturn continue to dampen risk appetite.

The yield on 10-year sovereign bonds slipped to 2.21 per cent on Thursday, a level not seen since at least as far back as 2002, bringing the drop this year to 35 basis points, according to Bloomberg data. Yields on 20-year and 30-year Chinese government bonds are down 41 and 36 basis points this year respectively, hovering around record lows.

The unrelenting demand for these risk-free debt instruments issued by Beijing comes amid a shaky recovery in the world's second largest economy. The latest government data on Thursday showed a sharp slow down in industrial profits growth last month because of weak domestic demand, reinforcing market jitters after a mixed bag of macro data for May.

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The poor performance of risk assets further eroded investor confidence. The Shanghai Composite Index fell 0.9 per cent on Thursday, dipping below the 3,000 psychological floor and erasing all of its 2024 gains, making it one of the worst-performing major indices in Asia, Bloomberg data shows.

"It shows the market still expects growth to be muted going forward," Dong Chen, chief Asia strategist and head of Asia research at Pictet Wealth Management in Hong Kong, said in a media briefing on Thursday.

Domestic investors have grown more wary about the country's growth outlook in recent months, Goldman Sachs said in a note last week, citing recent meetings with onshore clients.

Potential tariff risks from the US, the sustainability of export strength and overcapacity in the industrial sector are all cause for concern. Declining property prices, slowing wage growth, and youth unemployment also continue to weigh on confidence, the Wall Street bank said.

Meanwhile, expectations for more monetary easing measures from the People's Bank of China are also putting pressure on the yields, according to Chen.

"I think the PBOC probably needs to do more" to stimulate growth, he said. "Interest rates, more likely than not, will stay more accommodative going forward."

The next move could come as early as next month, when President Xi Jinping meets top leaders of the ruling Communist Party at the so-called third plenum and charts the path for the next half-decade, according to UK asset manager abrdn.

"We believe that there will be a more supportive policy in the second half of the year, and it's possible that the PBOC could dial down interest rates after the third plenum next month," said Dongyue Zhang, head of abrdn's multi-asset investment solutions specialists in Hong Kong.

It is possible that the loan prime rate (LPR) will be lowered and even if it is not, there are other methods available to lower financing costs and stimulate credit demand, he said.

To be sure, the rally in sovereign bonds has pushed up valuations, and the room for further upside could be limited at this level. The PBOC has also indicated it may intervene from time to time to cool off the gains, Pictet's Chen said.

Still, the momentum is likely to hold up as long as economic growth stays muted, he said. "The yield will probably stay low until we see more solid signs of a better growth outlook, and so far we haven't seen it."

This article originally appeared in the South China Morning Post (SCMP), the most authoritative voice reporting on China and Asia for more than a century. For more SCMP stories, please explore the SCMP app or visit the SCMP's Facebook and Twitter pages. Copyright © 2024 South China Morning Post Publishers Ltd. All rights reserved.

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