(Bloomberg) -- China's bond market is signaling the central bank is being too slow to cut interest rates and may have to accelerate stimulus to rejuvenate the flagging economy.
The extra yield on the nation's 30-year bonds over their two-year peers has been shrinking for more than a year and this month slipped to the narrowest in more than a decade. That suggests traders are increasingly pessimistic about the growth outlook due to a chronic property crisis and persistent deflation. Many analysts see the curve remaining relatively flat as expectations for easing keep being set back.
“The perception is Chinese policymakers, not just the central bank, but policymakers in general have been very behind the curve,” said Adarsh Sinha, co-head of Asia foreign-exchange and rates strategy at Bank of America in Hong Kong. The shrinking yield curve reinforces “the fact that the central bank and the government needs to do more,” he said.
The spread between two-year and 30-year yields shrank to 45 basis points on Feb. 5, the narrowest since September 2013. Another gauge of the yield curve — the premium on two-year rates over six-month ones — has been inverted since late December, while the 10-year to 30-year spread contracted below 20 basis points this month, the least since 2007.
An inversion of the yield curve — where yields on longer-maturity bonds drop below those on shorter-term securities — is seen as a precursor of a recession as it predicts the outlook for the central bank to cut interest rates.
A number of economists have already flagged the need for additional easing in China this year, including potential cuts to the central bank's rate on one-year policy loans known as the medium-term lending facility. The People's Bank of China refrained from lowering the policy loan rate on Feb. 18.
Policymakers have instead taken a number of more targeted steps to revive growth, such as reducing lenders' reserve requirement ratio. Banks meanwhile lowered a key mortgage reference rate this week. The prevailing view among economists is that such initiatives are far short of what is needed.
Additional action from the central bank could also include allowing the yuan to weaken further, which would help combat deflation.
While China's two-to-30-year yield curve has yet to invert, its US equivalent has been mostly inverted since April 2022. The situation for Treasuries has been put down to the Federal Reserve's decision to raise interest rates rapidly to fight inflation after yields had been repressed by massive quantitative-easing policy following the pandemic.
The trend toward yield-curve inversion in China is likely to persist, according to Standard Chartered Plc.
“China's economic transition is a lengthy process, which will come with a long period of low inflation and more monetary policy easing,” said Becky Liu, head of China macro strategy at the bank in Hong Kong. “It's my expectation that China's yield curve will flatten further or even invert.”
--With assistance from Qizi Sun, Matthew Burgess and Garfield Reynolds.
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