China bond yields fall as economic recovery turns patchy, fueling bets on rate cuts

SHANGHAI/HONG KONG — Chinese government bond yields were pinned close to six-month lows on Wednesday, as investors expected cuts in interest rates following data showing the economy’s strong post-COVID bounce was giving way to a patchy recovery.

Yields on China’s benchmark 10-year government bonds stood at 2.745%, having dipped on Friday to 2.73%, which was the lowest since November 2022, when China’s stringent COVID curbs were still in place.

At the short-end, 3-month interest rate swaps were down 20 basis points in two weeks.

Yields, which move inversely to bond prices, had surged in the first quarter of this year after China dropped its zero-COVID protocols. But disappointing data, like the unexpected contraction in April manufacturing activity, indicated a patchy economic recovery.

“With the economy likely to move out of its post-pandemic sweet spot towards the end of the second quarter, we see a higher chance of rate cuts in the second half (of the year), especially if the Federal Reserve stops rate hikes and starts rate cuts,” said Ting Lu, chief China economist at Nomura.

Three mid-sized Chinese lenders on Friday reduced interest rates on some deposits, after Reuters reported that China nudged banks to cut deposit rates further, in its latest efforts to channel the country’s vast savings pool into spending and more productive investments.

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Analysts believe lowered deposit rates should improve banks’ net interest margins and allow them to cut lending rates to boost the economy.

“The deposit rate cut certainly boosted market sentiment and spurred bond bulls to make more bets,” said a trader at a brokerage.

The 5-year non-deliverable interest rate swap (NDIRS) , which reflects market projections for future rate moves, has fallen more than 20 basis points in the past month to its lowest level since November.

While the prospect of lower yields and hence rising bond prices should attract foreign portfolio flows into Chinese government bonds (CGBs), analysts doubted whether that would happen given the widening differential between U.S. and Chinese yields.

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“Outflows from CGBs are expected to persist as yield differentials are still in negative territory and U.S.-China tensions could weigh on foreign (buying) interest,” said analysts at DBS.

China’s yuan eased 0.6% against the dollar in April, when the greenback lost 0.9% against a basket of major currencies. Institute of International Finance (IIF) data showed net outflows for Chinese securities in April, including $3.8 billion from equities and $1 billion from debt.

Meanwhile, regulators from Beijing and Hong Kong will soon to launch the interest rate Swap Connect scheme on May 15, which will allow investors to access onshore interest rate derivatives that will improve their ability to hedge.

“The Swap Connect provides a more efficient way for international investors to hedge yuan bond investments accurately,” said Freddy Wong, head of Asia-Pacific fixed income at Invesco Ltd. (Reporting by Winni Zhou in Shanghai, additional reporting by Georgina Lee in Hong Kong Editing by Vidya Ranganathan & Simon Cameron-Moore)