China's bond market surges as 10-year yields hit lowest level since 2020

China bond market: China's government bonds experienced a continued rally on Friday, as 10-year yields reached their lowest point in almost four years. The surge is fuelled by increasing expectations of additional stimulus measures to support the nation's economic recovery.

China has been grappling with a sluggish recovery from the pandemic, coupled with signs of deflationary pressures, prompting calls for further monetary easing. 

Recent decisions by major commercial banks to reduce deposit rates have paved the way for potential policy rate cuts.

The yields on the 10-year government bond dropped to 2.525 per cent, marking the lowest level since April 2020. Yields and bond prices exhibit an inverse relationship.

Jingyang Chen, Asian FX strategist at HSBC, suggests that the People's Bank of China (PBOC) might shift its focus from foreign exchange stability to monetary easing. Chen anticipates a rate cut in China following the initiation of easing measures by the US Federal Reserve.

The Federal Reserve's historic monetary tightening in the past two years had widened yield differentials with China, adding downward pressure on the Chinese currency and constraining the room for easing in the world's second-largest economy.

However, with the Fed signalling a more dovish stance and expectations of rate cuts, the yuan has recovered much of its losses, providing policymakers with flexibility to implement rate cuts.

Market observers, such as Goldman Sachs analysts, anticipate the PBOC to cut policy rates in the first and third quarters of the year by 10 basis points each, along with a reduction in the reserve requirement ratio (RRR) in the second and fourth quarters by 25 basis points each.

Contrarily, Citi analysts expect easing measures to be implemented "as early as in the coming weeks, within this month." They project a total of 20 basis points in rate cuts and a 50 basis point reduction in banks' RRR in 2024.

China is set to renew 779 billion yuan ($108.70 billion) worth of medium-term policy loans scheduled for January 15, and there is speculation of a potential rate adjustment at the monthly Loan Prime Rate (LPR) fixing on January 22.

(With Reuters Inputs)