Several factors have caused Chinese government bond yields to remain well above G7 yields; diverse developments in monetary, economic and financial regimes between China and the G7, and China’s low exposure to the global financial cycle have perhaps been key.
Although yield differentials fell a little when G7 yields rose sharply pre-COVID-19, the gap between Chinese and the US government bond yields has remained substantial as shown in Chart 1.
Moreover, apart from a COVID spike in 2020, the Chinese yield curve has been stable since 2018
As well as low correlation with G7 yields in recent years, the Chinese 10s/2s yield curve has been more stable than most G7 yield curves in recent years, despite the PBOC not pursuing QE or formal yield curve control (unlike the Bank of Japan). Since 2018, apart from a brief COVID spike, the 10s/2s curve has moved within a narrow range of about 60 basis points. Even after the spike during the COVID pandemic in Q1 2020, Chinese yields and the yield curve rapidly mean-reverted, as Chart 2 shows. This is very different from the US Treasury curve, which has experienced far larger swings over the last three years.
Reasons for Chinese vs US bond yield differences
Instability in the US yield curve is due partly to pronounced swings in Fed policy rates and 2-year US yields, but also much higher volatility in 7-10yr yields than China. After tightening from 0-0.25% in Fed funds to a high of 2.5%-2.75% in Q4 2018, the Fed reversed its policy stance and reduced interest rates back to 0.25% in 2020, causing 1-3yr yields to decline almost 300bp in the process (see Charts 3 & 4).
But Chinese short-dated yields have also been volatile. Yields first rose when the PBOC tightened policy to slow the credit boom in the period 2016-18, before falling sharply as markets discounted a significant policy easing in response to the COVID shock in 2020. Since, they have settled to pre-crisis levels, while short-dated US government bond yields have remained low, despite a very recent uptick.
Integration of Chinese banks into the global economic cycle explains the Chinese vs G7 gap
The Chinese government bond market developed since the early 2000s in a monetary and economic regime with little integration into the global economic and financial cycle. Although the shadow banking system has developed apace in China since the Global Financial Crisis, Chinese banks largely missed it, and there are only four Chinese banks in the Financial Stability Board’s list of the 30 Globally Systemically Important Banks[1] (G-SIBs). Thus, most of the asset growth in Chinese banks has come from lending to finance domestic growth. Therefore, low global asset exposure of Chinese banks makes the domestic economy and financial system less exposed to shocks in other jurisdictions.
The independence of Chinese monetary policy from the G7 is also important
In addition, China has had more limited exposure to this global financial cycle. This means Chinese interest rates and monetary policy have been set largely independently of the G7, and particularly since the GFC, by the PBOC. And unlike the G7, the Chinese financial system did not experience major regime change after the GFC, as G7 policy interest rates fell to zero (or below in some cases), and central banks adopted QE programs.
A major structural break occurred after the GFC Chinese interest rates and bond yields were quite closely correlated with those of the G7.
Experience since the COVID-19 shock has again shown continuing divergence between China and the G7, with China largely missing the second and third COVID waves that have bedeviled much of the G7. This meant Chinese GDP growth rebounded strongly in Q4 2020, reducing pressure on the PBOC to decrease interest rates further in 2021, after only a modest 30bps policy easing in Q1 2020, when the virus first appeared in China. Therefore, bond yields have remained more stable in China during the COVID-19 period, in contrast with the G7.
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[1] Financial Stability Board 2020 list of G-SIBs; www.fsb.org/wp-content/uploads/P111120.pdf).
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Originally Posted on November 16, 2021 – Explaining the Differences Between Chinese vs US Bond Yield Curve
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