Prospects Rise for China’s Government Bond Yields to Break 2%, Deflation Premise Cracks as Rate Repricing Begins

Divergence between accommodative policy stance and rising market rates
Prolonged downturn despite property stimulus efforts
Debate over “low-rate growth” reignites, global markets on alert

Following the Iran war, a sharp surge in global oil prices is rapidly reshaping China’s government bond market. The low-rate environment that had been maintained on the premise of falling prices is beginning to waver, and markets are even raising the prospect that 10-year government bond yields will exceed 2%. As consumer price and production-related indicators move in tandem, markets have already begun to price in inflation expectations. With changes in the direction of rates anticipated, the recovery trajectory of the domestic real estate market is also at risk of being disrupted, and adjustments to China’s low-price export structure are increasingly seen as unavoidable.

Signs of rising government bond yields amid price rebound

According to Bloomberg, cracks have recently begun to appear in China’s government bond market, which had been operating under a deflationary premise—falling prices amid economic slowdown. Indicators such as consumer prices and retail sales have shown consecutive strength, suggesting a weakening of the bond rally. Currently, China’s 10-year government bond yield stands at around 1.8% per annum. According to the Korea Center for International Finance (KCIF), China’s bond issuance volume last year increased by 18.2% year over year, yet the unusual pattern of yields declining despite large-scale issuance has not been observed since March this year.

Bloomberg, citing multiple analysts, projected that China’s 10-year government bond yield will break out of its range and exceed 2% within the year. Lynn Song, chief economist for Greater China at ING, noted that “in an economy expected to grow at around 4% annually over the next decade, it is abnormal for 10-year yields to remain below 2%.” China Kaiyuan Securities also forecast that “yields will return to a 2–3% range in the second half of the year.” Compared with just a few months ago, when discussions focused on how much further rates should be lowered, the market’s benchmark has shifted rapidly.

Price dynamics are also showing a clear shift. Following the Iran war, rising global oil prices have increased manufacturing cost pressures in China, with price hikes observed across industries from chemical producers to the country’s largest baijiu makers. The spread between 30-year and 5-year government bond yields—highly sensitive to inflation expectations—has widened to its largest level in about four years, with further expansion not ruled out. In response, Goldman Sachs and Australia and New Zealand Banking Group (ANZ) have moved to withdraw or significantly downgrade expectations for rate cuts by the People’s Bank of China.

These developments contrast with the policy stance maintained by Chinese authorities just months earlier. In January, the People’s Bank of China adopted a “moderately accommodative” stance, setting price recovery and expanded liquidity supply as key objectives. The loan prime rate (LPR) was lowered from 3.35% in October 2024 to 3.10%, and then to 3.0% in May of last year, where it has remained unchanged for seven months. At the time, the central bank stated it would “maintain accommodative financing conditions to support reasonable growth in total credit and balanced loan expansion,” but the combination of war-driven oil price increases and a rebound in inflation is rapidly undermining the policy framework designed to address deflation.

Adjustment phase in monetary easing policy

Markets have focused on how these shifts will affect the real estate sector. As recently as early February, before the outbreak of the Middle East war, China had been moving to expand monetary easing measures, including rate cuts, to address the property downturn. Key measures included lowering lending rates and expanding the use of housing provident funds. The provident fund system, a long-term savings scheme accumulated monthly by employees and used for home purchase loans, was being broadened beyond lending support to include applications such as maintenance costs and home renovation, reflecting efforts to expand policy tools themselves.

Policy easing spread across major cities. Beijing allowed households with two or more children to purchase additional commercial housing within the Fifth Ring Road and shortened the required duration of social insurance and income tax payments for non-local buyers from three years to two. Shanghai eased restrictions by allowing non-local residents to purchase homes outside the Outer Ring if they had paid social insurance or income tax for more than one year. As a result, housing transactions in Beijing increased 33% between December 24, 2024, and January 25 of the following year compared with the previous month, while second-hand housing transactions in Shanghai rose 15%. Price increases were also observed in some regions, including Dalian (1.84%), Wuhan (0.74%), and Qingdao (0.51%).

However, recent market conditions are moving in the opposite direction. As of the end of March, the outstanding balance of personal mortgage loans at six major state-owned banks—China Construction Bank, Industrial and Commercial Bank of China, Agricultural Bank of China, Bank of China, Postal Savings Bank of China, and Bank of Communications—totaled 24.48 trillion yuan, equivalent to approximately $3.6 trillion, representing a year-over-year decline of about 710 billion yuan, or roughly $104.4 billion. This extends a downward trend that has persisted for more than three years since peaking at the end of 2022. Markets attribute this not primarily to interest rates but to shifts in consumer sentiment.

Demand patterns are also evolving. Since the COVID-19 pandemic, expectations for economic recovery in China have weakened, along with expectations for housing price appreciation, leading to a surge in early repayment demand from the end of 2022. Although the pace of early repayment eased somewhat last year as rates declined, the tendency to reduce debt has continued. A homebuyer in Chongqing stated that “loan interest exceeds investment returns,” indicating a preference to prioritize loan repayment upon deposit maturity. Sales among China’s top 100 real estate developers also declined 23% year over year in the first quarter, highlighting limited expansion into new market segments.

Rising global inflationary pressure

Globally, the debate over China’s “low-rate growth” has been reignited. In March, Chinese authorities officially set this year’s economic growth target at 4.5–5% during the Two Sessions. While described as the lowest target in 35 years since 1991, markets have questioned whether even this figure is politically calibrated. Li Hengqing, a China economist based in the United States, pointed to a 14.7% drop in local government land sale revenue last year—a key fiscal pillar—and argued that “as the gap widens between the 4.5–5% growth target and fiscal and tax indicators, it becomes increasingly difficult to dismiss the suspicion that China’s low-rate regime has been masking a slowdown in growth.”

The International Monetary Fund (IMF) also assessed that weakening economic vitality is unavoidable, citing sluggish private demand and a persistent decline in the GDP deflator. Indicators known as the “Li Keqiang Index”—including electricity consumption growth, rail freight volume, and bank loan growth—have been moving in directions inconsistent with official GDP data. This is compounded by a contraction in the real estate sector, which accounts for one-third of China’s economy. Real estate investment fell 17.2% year over year last year, while new housing starts declined 20.4%. These conditions raise concerns that market downturns could transmit stress to banks’ non-performing loans and the shadow banking sector.

Some optimistic views remain. On the 1st, the Financial Times reported that “amid expanding sell-offs in U.S. and European government bonds following the Middle East war, Chinese government bonds have instead emerged as a safe-haven asset.” That morning, China’s 10-year government bond yield stood at 1.81%, slightly lower than at the end of February, while the U.S. 10-year yield rose 0.38 percentage points to 4.34%, and UK gilt yields surged 0.7 percentage points. Vincent Chung of T. Rowe Price explained that “China benefits from captive demand capital, allowing it to absorb shocks more effectively,” while Jason Pang of J.P. Morgan Asset Management described it as “a very low-correlation investment alternative.”

Despite such interpretations, there is broad agreement that the “low-price exports” China has long supplied to global markets will weaken. If China’s export strategy—driven by excess capacity and subsidies to push large volumes of low-cost goods—begins to falter, the producer price index (PPI), which has declined for more than 30 consecutive months, will face pressure to reverse direction. Adam Marden of T. Rowe Price stated that “the disinflationary effect from China that has suppressed global inflation is weakening,” adding that “the world is entering a phase where it must absorb upward pressure on prices.” As China’s low-rate, low-inflation combination loosens, the impact is likely to spread across global interest rate and pricing systems.