China bonds rally with 10-year yield hitting a multi-decade low on rate cut expectations

China bonds rallied Monday with the 10-year yield dropping below the key psychological level of 2% to hit a multi-decade low, amid expectations that Beijing could expand its stimulus measures to shore up the economy.

Yields on China’s 10-year government bond, which move inversely to prices, fell to 1.9636% on Monday, data from LSEG showed, marking its lowest level in 22 years. 30-year bond yields dropped to 2.164%.

The bond rally is mainly driven by expectations of a further cut to the reserve requirement ratio for commercial lenders, Tommy Xie, head of Asia macro research at OCBC Bank, said in a note on Monday. RRR determines the amount of cash that banks must hold in reserves.

He also cited “supportive liquidity condition and still weak economic fundamentals” as helping drive the rally.

The decline in yields comes after the People’s Bank of China announced last Friday that in November it had injected 800 billion yuan into the banking system, via a so-called “outright reverse repo operation.” That was ramped up from the 500 billion yuan injection in October.

The move was aimed at “keeping liquidity in the banking system adequate at a reasonable level,” the official statement read.

Separately, the central bank also said it had purchased a net 200 billion yuan of government bonds in open market operations in November, aimed at “intensifying counter-cyclical adjustment of its monetary policy.”

Chinese authorities have attempted to stem the bond market rally, fueled by investment piling into the safety of Chinese government bonds amid slowing economic growth and a lack of attractive investment options.

The PBOC has cautioned about the risks of destabilizing bubbles as investors chase government bonds while shunning more volatile assets.

“The market is still pricing in some fiscal stimulus support early next year,” Edmund Goh, investment director at abrdn, told CNBC.

Despite some encouraging signs of recovery in China’s property market, “we didn’t see any improvement in domestic economic data in the last few months,” Goh said, stressing that lower yields reflected that economic situation.

“Without any meaningful fiscal stimulus, China will see the economy moving into a deflationary state,” he added.

Chinese offshore yuan weakened by 0.45% on Monday to 7.2795 on the dollar.

PBOC Governor Pan Gongsheng said in a high-level meeting in November that the authorities planned to maintain supportive monetary policy and indicated the RRR would be lowered by 25 to 50 basis points by the year-end. He also suggested that the seven-day reverse repo rate could be cut by another 20 basis-point before the end of the year.

“The resistance for further downside [on bond yields] may increase due to higher government bond issuance and upcoming major meetings,” OCBC’s Xie noted.

China is expected to hold a closely-watched meeting by the Politburo, the top decision-making body of the ruling Communist Party, followed by an annual central economic work conference, where the policymakers will set the economic plans and growth target for 2025. Both meetings are expected to be held around mid-December.

At these meetings, Beijing is likely to announce additional stimulus measures, “which may alter market dynamics and reduce the scope for further declines in yields,” OCBC’s Xie added.

“Even though Chinese yields are now nearing 2%, the spread with U.S. 10 year yields has actually tightened,” Eugene Hsiao, head of China equity strategy at Macquarie Capital pointed out. “This is a net positive for Chinese equity flows,” he added.

China’s 10-year yield remains far lower than the U.S. 10-year Treasury yield of over 4%.