China's Inflation and Global Bond Market Challenges

By Jamie McGeever

As we look ahead to the day in Asian markets, China's latest inflation report is set to be released on Thursday. This announcement is particularly significant given the current state of turmoil in global bond markets.

Recently, long-term bond yields across the globe have surged as investors fear persistent inflation might prompt the U.S. Federal Reserve and other central banks to reconsider or even suspend their plans to cut interest rates. Notably, the 30-year UK gilt yield has reached its highest level since 1998, while the 30-year U.S. Treasury yield is nearing 5%. Furthermore, the risk premium, or 'term premium,' that investors demand for lending money to the U.S. government has surged to its highest in ten years.

This upward trend in yields suggests investors are concerned that inflation is still a major issue and that central banks may struggle to manage the longer-term impacts. However, Fed Governor Christopher Waller seems somewhat optimistic. He stated on Wednesday that he believes inflation will eventually decline towards the Fed's 2% target, which could allow for additional rate cuts in the future.

Despite this optimism, minutes from the Fed's previous policy meeting reveal that officials are cautious, especially regarding potential fiscal policies anticipated from the new Trump administration. Currently, money markets are only pricing in about 40 basis points of easing from the Fed this year, and the year-on-year rise in oil prices has reached its highest level in six months, indicating that inflation concerns are rising.

In stark contrast to the global trend, China is grappling with deflation rather than inflation. As noted by Jim Bianco from Bianco Research, China is unique as it is the only major bond market experiencing falling yields. The annual producer price index (PPI) has shown negative inflation since October 2022, highlighting a deflationary environment. Additionally, consumer inflation (CPI) has remained around zero and has not exceeded 1% for nearly two years.

The inflation figures for producer and consumer prices in China for December are expected to be released on Thursday. Economists, according to consensus forecasts from Reuters polls, anticipate that annual PPI inflation will slightly improve to -2.4% from November's -2.5%, while CPI inflation is expected to cool further to just 0.1% from 0.2%.

These circumstances have led to a decline in Chinese bond yields, which are now at historically low levels. The 30-year yield in China is below that of the 30-year Japanese Government Bond, and the 10-year yield is on track to drop below its Japanese counterpart as well. Analysts at HSBC have even lowered their year-end forecast for the 10-year Chinese bond yield to 1.2% from 1.8%.

The yuan is facing significant downward pressure, slipping to a new 16-month low on Wednesday. It is approaching the critical threshold of 7.35 per dollar, a level not seen since 2007.

Here are some key developments to watch that may influence the markets on Thursday:

- China PPI, CPI inflation (December)

- Australia retail sales (November)

- Taiwan, Australia, and Philippines trade data (December)

China, Inflation, Bond