Why are Chinese Government Bond Yields So Low and Why Does it Matter?

Chinese government 10-year bond (CGB) yields reached an all-time low last month, hitting 1.59% on Feb 6th, 2025. This decline occurred despite the Chinese government’s efforts to lower interest rates, boost consumption, and issue more ‘ultra-long’ special bonds.

Weakening investor confidence in China’s growth trajectory is evident, with some analysts predicting an annual GDP growth rate of 3.31% by 2029. This drop in yields is attributed to the slowing Chinese economy (for further details see my previous article), leading investors to seek the safety of government bonds over potentially risky stock investments. Additionally, low inflation exerts downward pressure on the yields of long-maturity bonds, as investors do not require a large inflation premium to maintain the value of their investments.

Given the market size ($17.7 trillion as of 2022), the lack of correlation between CGBs and US Treasuries and stock market, and its value as a hedge against the continuation of the US-China trade war, CGBs have become a key diversifying asset in many passive portfolios. However, the People’s Bank of China (PBoC) has recently warned investment managers to avoid greater investment in CGBs, as a bond bubble could undermine the government’s efforts to combat depreciatory pressures on the renminbi and revive stalling growth.

Foreign investment in Chinese bonds has declined steadily since January 2022, reflecting the economy’s uneven recovery from the Covid-19 pandemic. Participation from abroad in local currency bond markets has both pros and cons. Scholars argue that by diversifying the institutional investor base and creating greater demand for local market debt securities, foreign investors could stimulate the growth of local bond markets. Conversely, an increased foreign presence could lead to greater volatility in local bond markets. Recent studies have shown that a 1% increase in foreign ownership reduces Chinese 10-year government bond yields by 1-1.6%.

To address this issue, PBoC Governor Pan Gongsheng has suggested simplifying policy rates to the seven-day reverse repo rate (where the Bank buys securities from financial institutions to sell them back a week later) and downplaying the medium-term lending facility, which offers one-year loans to banks. He also aims to reduce fluctuations in short-term bank borrowing costs. This strategy is likely an attempt to reshape the yield curve to an upward slope, as long-maturity bonds offering similar returns to short-term bonds undermine the profits of banks that ‘lend long’ and ‘borrow short’. By taking these steps, the PBoC hopes to avoid the issues faced by the Bank of Japan, which led to its unorthodox monetary policy.

Ultimately, the future of CGBs will depend on the scale of China’s economic growth in 2025, which may entice investors back to the stock market.