China bond market diverges from US as Warsh strikes hawkish tone at Jackson Hole

The bond markets in China and the US are showing significant differences as economic data from China falls short of expectations, while Federal Reserve Chairman Kevin Warsh expresses a hawkish tone regarding fiscal sustainability. The yield on China's 10-year government bond reached 1.692% on Monday, nearing its lowest level in a year following July's economic figures coming in below analyst estimates.

Various brokerages forecast that yields could drop as low as 1.65%. In contrast, the US saw the 30-year yield hovering near a two-decade peak of 5.304%, as investors continue to seek the term premium despite Treasury Secretary Scott Bessent's pledge to double a buy-back program to mitigate the bond rout. Warsh's surprisingly hawkish remarks at the Jackson Hole symposium on Friday contributed to the Treasury rout, as he emphasized price stability over employment.

Warsh's shift from forward policy guidance to market communications may introduce additional volatility to US Treasuries. Analysts predict that the volatility in US Treasuries might be greater than initially anticipated. Li Xianglong, an analyst at Great Wall Securities, noted that while US Treasuries may experience more volatility, China's bond market will continue to operate independently.

The divergence between the two largest global debt markets could have significant implications for global capital flows, as investors look to diversify from US assets due to mounting fiscal deficits and excessive bond issuance by the Trump administration. Both China and the US face policy differences, with China under pressure to lower interest rates to combat deflation and the US to raise borrowing costs to curb inflation driven by oil shocks.

China's bond market has seen a surge in the past month, with investors flocking to seek protection from the turmoil in technology stocks and an economic slowdown. Retail sales, industrial production, and fixed-asset investment all fell short of analysts' expectations in July, with property prices declining and deflationary pressures resurfacing.

There is growing concern among investors regarding the need to lower borrowing costs to prevent further economic deterioration. The 10-year yield dropped to 1.677% on August 14, the lowest since July of the previous year. An appreciation of the yuan and a strong bond market attracted foreign investment, with Chinese government bonds receiving 9.5 billion yuan ($1.4 billion) in purchases for the third consecutive month in July, according to central bank data.

China's debt market, valued at nearly 200 trillion yuan, is the second-largest globally, following the US. Foreign investors hold around 2% of the market, equivalent to approximately 4.3 trillion yuan. Experts forecast that long-term US Treasury yields may remain elevated due to factors such as a robust American economy, increased funding demands for artificial intelligence, and rising Japanese bond yields, potentially limiting demand for American debt.

Analyst Scott Solomon at T. Rowe Price emphasized that persistent inflation, volatile energy prices, robust US growth, AI-related investments, growing fiscal and corporate supply, and shifting Japanese demand for overseas bonds could maintain upward pressure on longer-dated sovereign yields.