By Jiaxing Li, Summer Zhen and Li Gu

HONG KONG/SHANGHAI (Reuters)

Investors in Chinese bonds head for 2025, betting on no miraculous recovery in the economy, contrary to the equities market, which anticipates a revival in consumption.

Although China's closed capital account reduces the 33 trillion yuan ($4.6 trillion) bond market’s value as an economic forecaster, the persistently low ten-year bond yields and long bonds falling below Japanese yields indicate a deep-seated negativity in outlook.

"The bonds are basically saying that, yes, there is a (stock market) rally out there, but we don't buy this rally for the long term," said Bhanu Baweja, chief strategist for UBS Investment Bank in London.
"Bonds are saying that this is not an earnings-based rally, this is not a reflation-based rally."

A benchmark ten-year yield, down over 80 basis points this year to a record low of 1.78%, reflects a banking system overflowing with cash and a market broadly foreseeing slow growth and minimal inflation.

Bond prices move inversely to yields and are affected by a mix of inflation expectations, interest rates, creditworthiness, and the risk appetite in other asset classes.

Since September, following China's interest rate cuts and promises to stabilize financial and property markets, equity markets have rallied, pushing price-to-earnings ratios sharply higher.
Conversely, bonds have reacted oppositely, especially long-term bonds, where 30-year yields have fallen below 2%. For comparison, Japan's yields are at 2.24%.

"I think the Chinese bond yields should be lower if they reflect the current economic situation in the country," said Edmund Goh, investment director of fixed income at abrdn in Singapore.
"It’s difficult to foresee meaningful inflation given the current property situation in China, and the government is determined to avoid creating another property bubble."

In March, China set a growth target of "around 5%" for this year, but the economy has struggled with momentum, growing just 4.6% in the third quarter.
Goldman Sachs projects a slowdown to 4.5% next year.

LITTLE RESISTANCE

Part of the backdrop to the bond rally is a lack of alternatives. Chinese banks hold more than 300 trillion yuan in deposits, and with weak loan growth, much of this flows into money markets and bonds, pushing yields down.

The yield on the popular Tianhong Yu'Ebao money fund, China’s largest with over 600 million investors, reached a record low of 1.266% this week.

"Onshore lenders face a decision: give loans to businesses or invest in risk-free Chinese government bonds," said Clarissa Teng, fixed income allocation strategist at UBS global wealth management in Hong Kong.
"Many are opting for bonds, especially with soft credit demand from households and corporates."

Risks to the bond market stem from factors supporting equities, such as the possibility of a substantial fiscal spending plan from China requiring extra borrowing and leading to higher inflation, which would negatively affect bonds.

China's central bank has shown discomfort with the bond rally and has actively sold bonds to curb it. Foreign investors, including BlackRock, have also sold bonds to book profits after the long rally.

Nonetheless, most investors believe the rally will continue, with Li Kai, CIO of Beijing Shengao Fund Management, projecting a 10-year yield of 1.6% next year, and others remaining confident.

"We struggle to find reasons to be pessimistic about the sovereign bond market," stated analysts at Shanghai-based Shoupu Asset Management in a November letter to investors.
"The facts of economic fundamentals are evident, and without strong, targeted growth-stabilizing policies, there is little resistance to the decline in bond yields."

($1 = 7.2760 Chinese yuan renminbi)