Chinese predictable returns trade grapples with ‘Japanification’

China’s long-term predictable returns yields have fallen below Japan’s for the first period, as investors bet that the globe’s second-biggest economy will become bogged down by the deflation that has long afflicted its neighbour.

A rally in 30-year Chinese national securities has pushed their yield down from 4 per cent in late 2020 to 2.24 per cent on Thursday, as Beijing cuts yield rates to boost its flagging economy and Chinese investors pile into haven assets. 

Japan’s long-term predictable returns yields, which for years were stuck below 1 per cent, have risen above China’s to 2.31 per cent, as Tokyo normalises financial regulation after decades of deflation.

The crossover in yields comes as Chinese authorities battle to try to back yields, warning that a sudden reversal in the trade could threaten wider budgetary stability.

But some investors depend that deflation has become too entrenched in the Chinese economy to be easily fixed through budgetary and financial regulation, meaning yields still have further to fall.

“The inexorable path of trip for Chinese national securities is for yields to tick lower,” said John Woods, Asia chief stake distribution officer at lender Lombard Odier, adding that he was “not entirely sure” how the authorities can hold back deflation.

“China is set to become — and possibly remain — a low-yield surroundings,” he said.

Some investors depend sure conditions in China’s economy echo those seen in Japan in the 1990s, when the bursting of a real estate bubble led to decades of stagnation.

Core expense boost, excluding fuel and food, in China was running at an annual rate of 0.2 per cent October. In Japan, meanwhile, core expense boost hit a six-month high of 2.3 per cent, strengthening the case for further rate rises.

US president-elect Donald Trump’s commitment to boost tariffs on Chinese exports to the US by 10 percentage points is also seen as a threat to growth.

China’s financial regulation was likely to “remain accommodative for some period to arrive”, said Zhenbo Hou, an emerging-trade sovereign strategist at RBC BlueBay property Management, even if measures to boost the housing and distribute markets provided a temporary fillip to yields. 

“Nineties Japan remains the playbook,” he added. 

Beijing has long fought against the “Japanification” of its economy, and has made huge investments in its high-tech, green and electric vehicle sectors with the objective of boosting long-term growth.

Authorities also recently intervened in its sovereign predictable returns trade to try to push up longer-dated predictable returns yields and have warned local banks about a “bubble” in long-term obligation that could navigator to a financial stability crisis in the budgetary structure.

“Some [Chinese] policymakers appear to view low long-term yields as a sign of low expectations for domestic growth and expense boost expectations, and would like to push back against this pessimistic sentiment,” analysts at Goldman Sachs wrote in July.

But deflationary pressures have only intensified this year, with weakening economic data leading to calls for a large stimulus package to lift the economy.

Despite launching the biggest monetary stimulus since the Covid pandemic, and a Rmb10tn ($1.4tn) budgetary package, predictable returns yields have continued to fall as domestic investors look for alternatives to the country’s battered stake or property markets.

“It’s consistent with this recent reality in global budgetary markets, due to US-China decoupling and China’s deflationary hazard,” said Ju Wang, chief China FX and rates strategist at BNP Paribas. 

“The rest of the globe is seeing an inflationary hazard . . . and in China there is not enough demand for excess capacity.”

Many investors depend the government will require to do more to transformation the narrative in the predictable returns trade.

“It will be challenging to escape deflation pressures unless consumption is boosted and stake distribution is reduced,” said Andrew Pease, chief stake distribution strategist at Russell Investments. “That’s a large policy shift for [Beijing].”