Did China's Bond Market Just Do the Central Bank's Job for It?

China could hold off on rate cuts thanks to record low Treasury yields.

The Chinese central bank could hold off on interest rate cuts that were flagged at the end of last year, as part of Beijing’s ambitious macroeconomic stimulus package for 2025.

This is because a recent drop in Chinese Treasury yields to historic lows may have already achieved the central bank’s goal of reducing long-term borrowing costs.

A brief history of modern Chinese macroeconomic policy

Since 1993, China has followed the lead of nominal free market nations , by using a combination monetary and fiscal policy to implement macroeconomic adjustments.

This began with the 14th 3rd Plenum of November 1993, which called for “changing the role of government, and establishing a health macroeconomic adjustment system.”

Guan Tao (管涛), chief economist at the investment banking vehicle of Bank of China, says in subsequent decades the Chinese central bank has see-sawed back and forth between loose and tight monetary policy.

It’s tightened to deal with bouts of inflation, and loosened to boost growth during periods of flagging economic momentum.

Guan further argues that ever since the end of 2011, China has been in the midst of a long-term monetary loosening cycle that has extended for well over a decade, to deal with the fallout created by the Global Financial Crisis, as well as the headwinds of Trump's trade war.

From November 2011 to December 2024, China’s central bank cut the required reserve ratio on 23 occasions, for cumulative reductions of 12.0 percentage points for large banks and 13.0 percentage points for small and medium-sized banks.

It’s also created a slew of new structured monetary policy tools, to provide targeted support to desired sectors of the Chinese economy.

As of the end of September 2024, the balance of these tools was 6.66 trillion yuan, equal to 17.6% of the base money supply.

China commits to loose monetary policy in 2025

At the end of last year, Beijing made reference to the need for “moderately loose policy” - the first time the phrase has been invoked by Chinese officials in over a decade.

China wants monetary policy to further loosen, as part of an ambitious macroeconomic stimulus program that seeks to achieve long-awaited structural adjustments.

This will help China deal with the economic headwinds created by a second Trump presidency, as well as anaemic domestic demand induced by a multi-year property slump.

At the start of 2025, the Chinese central bank signalled that it would cut interest rates and the required reserve ratio “when necessary,” to loosen up monetary policy settings.

China’s bond market gives the central bank a helping hand

Guan argues, however, that startling changes on China’s bond market mean the central bank may not yet need to cut interest rates.

Long-term bond yields in China recently fell to record lows, causing alarm and consternation amongst both domestic and overseas observers.

The 10-year Chinese treasury yield fell below 2% on 2 December 2024, then 1.6% after 9 December, when the Politburo flagged loose monetary policy at a key end-of-year meeting.

Many observers consider the paltry yields to be partially the result of an “asset drought” on Chinese financial markets, which compels institutional investors to hold undue volumes of government bonds.

Concerns over the fall in long-term yields prompted the central bank to announce on 10 January 2025 it would temporarily suspend treasury purchases, helping bond prices to ease and interest rates to rise as a consequence.

Guan points out, however, that low yields on the bond market have actually “helped” the central bank, by sparing it from the need to cut its official policy rates.

This is because treasury yields can be used by Chinese banks as the reference rate for setting rates for long-term deposits, ever since interest rate reforms implemented in 2022.

“While the market may have been full of expectations of a more vigorous cut to rates, these expectations have repeatedly fallen empty,” Guan writes.

“The deeper reason is that the market may have already helped the central bank to implement reductions to interest rates.

“The decline in the 10-year treasury rate has already had the effect of a rate reduction on the domestic bond market.”