Inflation is playing a big role here. While the rest of the world is scrambling to tamp down persistently elevated price pressures, China is continuing its multi-year fight against deflation. The property crash that began in 2021, the biggest in history, is still weighing on consumption, economic activity, and consumer price inflation.
But there are tentative signs that a corner is being turned. Annual producer price inflation, which had been negative for almost four years, burst into positive territory earlier this year, topping 4% in June. China's GDP deflator also turned positive in the second quarter after being negative for four years.
So shouldn't bond yields in China be trending higher, if not as steeply as G7 yields, but at least rising?
Some may point to the country's fiscal foundations, which appear more robust on the surface than those of many peers. China's official government debt-to-GDP ratio this year is projected to be 75%. That's substantially lower than the debt loads of all G7 countries except Germany's.
However, there is a fair degree of opacity surrounding the country’s debt levels, with the lines between central, state and local governments often blurred.
The International Monetary Fund's "augmented debt" measure for China, which includes other borrowings like those through local government financing vehicles, paints a much less rosy picture. This debt load is expected to hit 136% of GDP this year and rise above 150% by the end of the decade.
That's closer to U.S. and Italian levels of indebtedness, which the current “bond vigilante” narrative suggests are unsustainable.
"If one were looking only at the fiscal profile, China's bond yields should be higher than the West's, not lower," analysts at Barclays note. "A deteriorating balance sheet, a collapsing property market that has gutted local government revenue, and off-balance-sheet liabilities – this is not the profile of a 1.70% borrower. Yet here we are."
TLT•
