(Bloomberg) — Chinese bonds may be reaching a historical turning point, with yields set to climb from record low levels as deflationary pressures ease and expectations for monetary loosening recede.<\/p>\n
The benchmark 10-year yield has the potential to finally break out of its recent narrow trading range and rise toward 2% or even higher this year from around 1.8% now, some analysts say. Meanwhile, the yield spread between five-year and 30-year notes, a measure of inflation expectations and supply pressure, has reached its widest in about four years and the gap may increase.<\/p>\n
Sentiment in the largest emerging debt market has shifted after a slew of upbeat data, from a surprise growth rebound to slower factory-gate price declines, cast fresh doubts on a deflation-driven narrative that has dominated trading in recent years. As nations around the world adjust to the new reality of elevated oil prices caused by the war in Iran, some analysts even suggest the rise in Chinese yields may have repercussions across emerging bond markets.<\/p>\n
\u201cThe deflation trade has reached an inflection point,\u201d said Lynn Song, chief economist for Greater China at ING Bank. \u201cIt is not a normal situation for an economy expected to grow around 4% for the next decade to have 10-year yields under 2%.\u201d<\/p>\n
Some local brokerages are even more aggressive in calling for sharper gains in yields. Kaiyuan Securities Co., for one, sees the benchmark yield returning to a range of 2%-3% later this year as inflation gains momentum.<\/p>\n
Signs of repricing intensified last month, when the inflation-sensitive 30-year yield briefly hit the highest since September 2024, after data showed a consumer price uptick and moderating factory deflation, as well as an expanding export boom and stronger retail sales. China\u2019s interest-rate swap market is also flashing signals of reduced expectations for further policy easing by the People\u2019s Bank of China.<\/p>\n
The brighter outlook for the world\u2019s No. 2 economy has prompted global banks including Goldman Sachs Group Inc. and Australia & New Zealand Banking Group Ltd. to withdraw or scale back forecasts for a PBOC rate cut this year. Some of these banks also revised up their inflation forecasts for China following the oil shock resulting from the Middle East conflict.<\/p>\n
The shift in bond markets hasn\u2019t been confined to China, with the average yield on emerging-market local-currency bonds climbing to the highest in almost two years in March. Energy importing nations saw a big selloff, with bond yields jumping by 50-100 basis points in Poland, South Africa and Thailand.<\/p>\n
If the upward trend in Chinese yields intensifies, it may result in implications for other markets.<\/p>\n
Adam Marden, co-portfolio manager for Dynamic Global Bond Strategy at T. Rowe Price, argues that \u201cthe disinflationary impulse\u201d from China, which has helped suppress global inflation in recent years, is now fading. With rising oil prices adding to inflationary pressures, he sees a higher probability of higher yields alongside flatter yield curves globally, which could create a more challenging situation for central banks.<\/p>\n
To be sure, any so-called \u201creflation trade\u201d for bonds faces challenges such as the possibility of a quick end to the Iran war that may significantly ease oil prices, as well as renewed weakness in China\u2019s domestic demand. Morgan Stanley, for one, said China\u2019s inflation rebound is \u201cunlikely to be sustained\u201d and expects its producer price index to slip back into mild deflation in 2027.<\/p>\n
In addition, while Chinese government bonds have emerged as a shelter for investors during the Iran war and there are even expectations for it to become a reserve asset, they have suffered four consecutive years of foreign outflows. Whether there\u2019s a sustained return of international investors to the market would help determine if it reaches an inflection point.<\/p>\n
But for now, there\u2019s a growing view among analysts, including those from Citigroup Inc. and Huatai Securities Co., that China\u2019s producer price index will return to positive territory soon.<\/p>\n
There are signs that the momentum is building, with companies from chemicals producers to the country\u2019s top liquor maker announcing price hikes. Meanwhile, China\u2019s property market is showing some stabilization after a years-long slump, with activity rebounding in major cities in March.<\/p>\n
\u201cChina\u2019s rising inflation will likely be a turning point for the bond market,\u201d said Jeffrey Zhang, a strategist at Credit Agricole CIB. \u201cThe ongoing curve re-steepening trend will likely quicken if upcoming inflation indicators suggest that price pressures from the oil shock outweigh demand concerns.\u201d<\/p>\n
What to Watch<\/p>\n
Central bank decisions this week include India on Wednesday, Poland and Peru on Thursday, as well as South Korea on Friday<\/p>\n
Inflation prints are due this week from Thailand and China<\/p>\n
–With assistance from Marcus Wong.<\/p>\n