China Economy: Bond traders signal need for more fiscal support as yields fall

• Despite recent stimulus efforts, Chinese investors continue to stockpile safe-haven assets.
• The 30-year Treasury yield hit its lowest level since 2005 last week and fell again on Monday amid further action.
• Bank of America says fiscal stimulus and housing market support could reverse this trend.

While Chinese stocks have rallied sharply following Beijing’s stimulus push, the country’s bond market shows skepticism remains.

Early last week, policymakers announced a series of measures, including interest rate cuts, liquidity support and reduced bank reserve requirements. Stock markets loved it, with China’s CSI 300 index rising 16%, its best week since 2008.

But the bond market seemed less convinced by the stimulus attempt, as the yield on 30-year government bonds fell the next day to near its lowest level since 2005. Theoretically, if fixed-income investors were appeased, they would leave the relative safety of bonds behind, causing yields to rise. Instead, the opposite happened.

The same dynamic played out on Monday, following more determined efforts by China to address its weakening real estate market. Three of the country’s largest cities have loosened rules for homebuyers, and the People’s Bank of China has also moved to lower mortgage rates.

These moves sent stocks soaring again, with the CSI 300 index rising 8.5%, its best day since 2008. Once again, the 30-year Treasury yield fell 8 basis points to 2.36%. While this is above the multi-year low of 2.14% recorded last week, it is still a surprising directional move.

Investors may be reacting to the widely held view that despite the size and scope of China’s stimulus measures, they may still not be enough. The country is struggling with deflation, low consumption and a real estate debt crisis. While additional liquidity may boost confidence in the stock market, analysts say it does little to fix underlying problems. Instead, China should spend more on its consumers.

“The net supply of government bonds increased significantly in August to CNY 1.85 trillion, driven by higher issuance by both central and local governments,” Bank of America wrote in mid-September. “Until we see a significant increase in fiscal stimulus to stabilize consumption and the housing market, the downward trend in rates is unlikely to reverse.”

Supportive measures could include either an upward revision of China’s fiscal deficit target or the issuance of special refinancing bonds by local governments, he said.