China's surprising bond boom

Between the lines: Yields on Chinese government bonds are near record lows, with the 10-year now yielding less than 2.2%. Among major economies, only Japan and Switzerland have lower equivalent borrowing costs.

• "Investment in China was driven by real estate, which collapsed. Chinese stocks have been doing really poorly," Alicia Garcia Herrero, an economist at Natixis, tells Axios.
• "This means that there is nothing left," Garcia Herrero adds — government bonds are "all you have."

The bond rally has started to reverse some after the Chinese government stepped in to try to stave off buyers.

• Bloomberg, Reuters and other publications have reported that regulators have told some banks not to settle investors' purchases of government bonds. They have also implemented more onerous reporting requirements for institutions' bond-trading activities.
• In earlier months, China's central bank also said it would lean more on the buying and selling of government bonds in its approach to monetary policy.

The big picture: The latest round of key data suggests China's economy is still stuck in a prolonged downturn. The unemployment rate is rising. Property prices are falling at an increasing rate. Both factors are discouraging consumer spending.

• New home prices fell 4.9% in July from a year earlier, the fastest drop in nine years, according to calculations by Reuters.
• The unemployment rate ticked up last month by 0.2% to 5.2%. Among those aged 16 to 24, the jobless rate spiked above 17% — the highest since the government resumed releasing the data in December.
• Retail sales rose 2.7% in July from a year earlier, the government said last week — an improvement from the prior month that came because of favorable seasonable factors, economists said.

One bright spot in China's economy in recent months has been its factory sector that has ramped up the production of goods, including green technology products (much to the dismay of politicians in the U.S. and Europe).

In a surprise move, China's central bank cut interest rates last month, the latest effort to support the flagging economy.

• But the speed and scale of the bond market rally is alarming officials, who recently have cited the Silicon Valley Bank meltdown in the U.S. last year as the kind of crisis that can arise when long-term interest rates move rapidly.

What they're saying: "Policymakers are concerned about the possibility of this developing into a bond market bubble," ING China economist Lynn Song wrote in an email to Axios.

• There is an element of financial risk: If banks are overexposed to government bonds, and there is an eventual sell-off, that could lead to losses on their balance sheets, Song says.
• In a speech earlier this summer, China's central bank chief said the Silicon Valley Bank saga showed that policymakers needed to "correct and intercept the accumulation of market risks in a timely manner."

Flashback: SVB bought up low-rate longer-term bonds in 2020 and 2021, then was stuck with huge paper losses when rates rose in 2022.

• This triggered an equity sell-off followed by a depositor run on the bank in March 2023 that was stanched only after the U.S. government pledged to protect uninsured depositors.

There is also risk for Chinese insurance firms with funds parked in government debt. The lower-yielding debt means they will struggle to pay out policies with fixed, higher returns.

• This dynamic would make "insurance companies technically bankrupt; this is one of the key issues," Garcia Herrero says.

What to watch: There might be a secondary factor at play in China, Song says.

• China's moves may be an attempt to nudge investors toward riskier asset classes. "Stabilizing the price decline in property and equity prices would play a big role in improving confidence."