China is easing monetary policy. The economy needs fiscal support

BEIJING — China’s slowing economy needs more than interest rate cuts to boost growth, analysts said.

The People’s Bank of China on Tuesday surprised markets by announcing plans to cut a number of rates, including that of existing mortgages. Mainland Chinese stocks jumped on the news.

The move may mark “the beginning of the end of China’s longest deflationary streak since 1999,” Larry Hu, chief China economist at Macquarie, said in a note. The country has been struggling with weak domestic demand.

“The most likely path to reflation, in our view, is through fiscal spending on housing, financed by the PBOC’s balance sheet,” he said, stressing that more fiscal support is needed, in addition to more efforts to bolster the housing market.

The bond market reflected more caution than stocks. The Chinese 10-year government yield fell to a record low of 2% after the rate cut news, before climbing to around 2.07%. That’s still well below the U.S. 10-year Treasury yield of 3.74%. Bond yields move inversely to price.

“We will need major fiscal policy support to see higher CNY government bond yields,” said Edmund Goh, head of China fixed income at abrdn. He expects Beijing will likely ramp up fiscal stimulus due to weak growth, despite reluctance so far.

“The gap between the U.S. and Chinese short end bond rates are wide enough to guarantee that there’s almost no chance that the US rates would drop below those of the Chinese in the next 12 months,” he said. “China is also cutting rates.”

The differential between U.S. and Chinese government bond yields reflects how market expectations for growth in the world’s two largest economies have diverged. For years, the Chinese yield had traded well above that of the U.S., giving investors an incentive to park capital in the fast-growing developing economy versus slower growth in the U.S.

That changed in April 2022. The Fed’s aggressive rate hikes sent U.S. yields climbing above their Chinese counterpart for the first time in more than a decade.

The trend has persisted, with the gap between the U.S. and Chinese yields widening even after the Fed shifted to an easing cycle last week.

“The market is forming a medium to long-term expectation on the U.S. growth rate, the inflation rate. [The Fed] cutting 50 basis points doesn’t change this outlook much,” said Yifei Ding, senior fixed income portfolio manager at Invesco.

As for Chinese government bonds, Ding said the firm has a “neutral” view and expects the Chinese yields to remain relatively low.

China’s economy grew by 5% in the first half of the year, but there are concerns that full-year growth could miss the country’s target of around 5% without additional stimulus. Industrial activity has slowed, while retail sales have grown by barely more than 2% year-on-year in recent months.