A China Resources property under construction in Nanjing, Jiangsu Province, China, September 24, 2024.
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BEIJING — Analysts say China will need more than interest rate cuts to accelerate growth in its slowing economy.
The People’s Bank of China surprised markets on Tuesday by announcing plans to cut several interest rates, including existing mortgage rates, sending mainland stocks soaring on the news.
Larry Hu, chief China economist at Macquarie Bank, said in a note that the move could mark “the beginning of the end of China’s longest deflation since 1999.” China has been struggling with weak domestic demand.
“In our view, the most likely path to reflation is fiscal spending on housing financed by the People’s Bank of China’s balance sheet,” he said, stressing the need for further fiscal support as well as further efforts to shore up the housing market.
The bond market was more cautious than the stock market. China’s 10-year government bond yield fell to a record low of 2% on the news of the rate cut, but has since risen to around 2.07%, still well below the 10-year U.S. Treasury yield of 3.74%. Bond yields move inversely to prices.
“Significant fiscal policy support will be needed to lift yuan bond yields,” said Edmund Go, head of China fixed income at abrdn. He expects the Chinese government will likely step up fiscal stimulus given weak growth, though he’s cautious for now.
“The gap between U.S. and Chinese short-term government bond rates is large enough that it’s highly unlikely that U.S. interest rates will fall below Chinese interest rates within the next 12 months,” he said. “China is also lowering interest rates.”
The difference between U.S. and Chinese government bond yields reflects how divergent market expectations are about the growth of the world’s two largest economies. For years, Chinese yields have far outpaced U.S. yields, giving investors an incentive to park their capital in fast-growing developing countries rather than the slower U.S.
However, that all changed in April 2022. Aggressive rate hikes by the Federal Reserve pushed U.S. yields above Chinese yields for the first time in over a decade.
This trend continues, with the yield gap between the US and China widening even after the Fed moved into an easing cycle last week.
“The market has formed medium- to long-term expectations for U.S. growth and inflation,” said Yifei Ding, senior fixed income portfolio manager at Invesco. “A 50 basis point rate cut by the Fed would not significantly change this outlook.”
Regarding Chinese government bonds, Ding said the firm has a “neutral” view and expects Chinese government bond yields to remain at relatively low levels.
China’s economy grew 5% in the first half of the year, but there are concerns that without more stimulus, full-year growth could fall short of the country’s target of about 5%. Industrial activity has slowed and retail sales have grown just over 2% year-on-year in recent months.
Hopes for fiscal stimulus
China’s finance ministry has remained conservative: Despite the unusual move that special bond issuance will increase the budget deficit to 3.8% in October 2023, authorities reverted to a more normal 3% deficit target in March this year.
Beijing still has a spending shortfall of 1 trillion yuan to meet its fiscal targets this year, based on government revenue trends and assuming planned spending is carried out, according to an analysis published on Tuesday by CF40, a leading Chinese think tank specializing in financial and macroeconomic policy.
“If general budget revenue growth does not recover significantly later this year, it may be necessary to widen the fiscal deficit and issue additional bonds in a timely manner to cover the revenue shortfall,” the CF40 research report said.
Asked about the falling trend in Chinese government bond yields, People’s Bank of China Governor Pan Gongsheng on Tuesday said one reason was a slowdown in the growth of government bond issuance and that the central bank was in discussions with the Finance Ministry about the pace of bond issuance.
Earlier this year, the People’s Bank of China repeatedly warned markets about the risks of jumping on a one-sided bet that bond prices would rise while yields fell.
Analysts generally don’t expect China’s 10-year government bond yields to fall significantly anytime soon.
After the People’s Bank of China announced the rate cut, “market sentiment has changed significantly, with more confidence in accelerating economic growth,” Zhang Haizhong, executive director at Fitch (China) Bohua Credit Rating, said in an email. “Given the above changes, we expect 10-year Chinese government bond yields to remain above 2% in the short term and not fall easily.”
He noted that monetary easing still requires fiscal stimulus to “achieve the effect of expanding credit and transmitting funds to the real economy.”
Zhang said this is because Chinese companies and households are highly leveraged and therefore hesitant to borrow, “which also weakens the marginal effect of monetary easing policies.”
Interest rates are affordable
The Federal Reserve cut interest rates last week, theoretically easing pressure on Chinese policymakers. Easing U.S. policy could help the dollar weaken against the Chinese yuan and boost exports, one of China’s few bright spots for growth.
China’s offshore yuan briefly hit its highest level in more than a year against the U.S. dollar on Wednesday morning.
“Lower U.S. interest rates will provide relief to China’s foreign exchange markets and capital flows, easing the external constraints imposed by high U.S. interest rates on the People’s Bank of China’s monetary policy in recent years,” Louis Kuijs, chief Asia-Pacific economist at S&P Global Ratings, said in an email on Monday.
As for China’s economic growth, he still called for more fiscal stimulus: “Fiscal spending is lagging behind budget allocations for fiscal 2024, bond issuance is sluggish, and there are no signs of substantial fiscal stimulus.”
