China Bonds Flash ‘Japanification’ Warning Despite Stimulus Plan

Promoters of the theory that China faces a “Japanification” of its economy look set to enjoy a symbolic milestone in the bond market.

The yield on China’s 30-year government bonds is on track to fall below its Japanese equivalent for the first time in about two decades. China’s long-term yields continue to plumb fresh lows amid a sluggish outlook for the world’s second-largest economy, while Japan’s have climbed to their highest in 13 years on bets the fourth-biggest has finally banished the scourge of deflation.

China’s economic struggles have fanned fears of a balance sheet recession like Japan experienced in the 1990s given an extended property slump, falling prices and weak demand for credit. Consumers and businesses opting to pay down debt following a real estate collapse were a hallmark of Japan’s fall into decades of deflation.

Chinese efforts to avoid what happened their regional neighbor ramped up this week as Beijing unleashed the most daring policy campaign in decades with measures such as cuts to a slate of policy rates and the mulling of a stock stabilizing fund. President Xi Jinping and top leaders also called for sufficient fiscal spending and support for the property sector.

The yield convergence “is a result of growing optimism that Japan will be able to escape its three decades plus of economic stagnation, combined with mounting pessimism over China’s medium to long-term outlook,” said Duncan Wrigley, chief China economist of Pantheon Macroeconomics. “China shares some of the features of Japan when it entered stagnation, such as the property sector downturn, balance sheet adjustment issues, asset price corrections and a demographic drag.”

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China’s 30-year yield fell to 2.14% this week, the lowest since at least 2005 while Japan’s climbed to about 2.07%, according to data compiled by Bloomberg. While China’s woes have boosted investor appetite for bonds as a haven, Japanese debt has sold off on the return of inflation and the end of the country’s negative interest-rate policy.

Despite the economic similarities between China now and Japan during its period of deflation, there remain plenty of differences.

For one, the People’s Bank of China has refrained from the types of unconventional stimulus like quantitative easing and massive bond buying that defined Japan’s response to its crisis. And the PBOC’s steps to better manage its yield curve include guiding longer-dated yields higher, not lower like Japan did.

And in the bond market, shorter-dated yields in China are much higher than their Japanese counterparts.

“China appears to be walking the path that Japan did but how it’s walking is different because of the difference in the political systems,” said Akira Takei, a fixed-income manager at Asset Management One Co. in Tokyo. “China is facing economic challenges, such as deteriorating demographics, that are building up like a mille-feuille.”

Still, for ING Bank NV, China’s latest stimulus package won’t be enough to deter demand for bonds and the downward trend in yields. That means Chinese yields may fall below those in Japan if the current trend continues.

“Lower interest rates will once again widen the gap between bank deposits and bonds, so I still think the long end CGB yields will trend downward in the near term,” said Lynn Song, greater China chief economist at the bank. “We will see money flow back into bonds.”