Morning Bid: China's Inflation and Global Bond Market Turmoil

By Jamie McGeever

As we look ahead to the Asian markets, all eyes are on the latest inflation data from China, which is set to be released on Thursday. This announcement comes at a particularly intriguing, if not unsettling, moment for markets worldwide, especially in the bond sector.

Across the globe, long-term bond yields are climbing sharply. This rise is largely due to investor expectations that persistent inflation will compel the U.S. Federal Reserve and other central banks to pause or even stop their current rate-cutting strategies. For example, the 30-year UK gilt yield has reached its highest level since 1998. Similarly, the 30-year U.S. Treasury yield is very close to hitting 5%. Additionally, the U.S. 'term premium'—the extra yield that investors demand for lending money for a longer term compared to shorter terms—has surged to its highest point in ten years.

These trends suggest that investors are growing increasingly worried that inflation is becoming entrenched, and that central banks may be losing control over longer-term interest rates. However, not everyone shares these concerns. Federal Reserve Governor Christopher Waller expressed a relatively optimistic view on Wednesday, stating that he still expects inflation to move toward the Fed's target of 2%, which would allow for potential rate cuts. Yet, the minutes from the most recent Fed policy meeting indicated that policymakers are cautious, especially regarding policy decisions anticipated from the incoming administration.

Market predictions currently show that investors are forecasting only 40 basis points of easing from the Fed this year, alongside the fact that year-over-year oil prices have risen to the highest level in six months, heightening inflationary concerns.

In stark contrast, China finds itself tackling deflation. As pointed out by Jim Bianco from Bianco Research, China is the only major bond market globally experiencing falling yields. Producer inflation in China has been negative for every month since October 2022, indicating ongoing deflationary pressures. Consumer inflation is near zero and has not surpassed 1% for nearly two years.

The upcoming release of China's producer and consumer price index (PPI, CPI) for December will be closely watched. The consensus forecast among economists surveyed by Reuters expects a slight shift in annual PPI inflation from -2.5% to -2.4%. Meanwhile, annual CPI inflation is projected to cool further to just 0.1% from 0.2%.

This backdrop is contributing to a historic drop in Chinese bond yields, which are now at their lowest levels ever. For instance, the 30-year yield in China is below that of Japan's 30-year Government Bond, and the 10-year yield is just shy of 50 basis points from being lower than its 10-year counterpart.

Analysts from HSBC have revised their projections for the 10-year Chinese yield, lowering it sharply from 1.8% to 1.2% by year-end.

Additionally, the Chinese yuan continues to face significant downward pressure, recently hitting a fresh 16-month low. It is on track to breach the low of 7.35 per dollar established in September 2023, potentially reaching levels not seen since 2007.

Here are some crucial market developments to watch for on Thursday:

• China's producer and consumer price index (PPI, CPI) for December
• Australia's retail sales data for November
• Trade figures from Taiwan, Australia, and the Philippines for December

China, inflation, bonds