China’s Bond Crash: Deflation, Debt, and Decline

Over the last month, China has faced a historic capital outflow of more than US$45.7 billion, significantly intensifying or at least reinforcing its economic challenges. This sharp escalation came on the heels of upcoming U.S. President Donald Trump’s re-election, which reignited investor fears of escalating trade tensions between the world’s two largest economies. A market doesn’t simply shrug off the threat of 100% tariffs by your biggest trade partner when you’re already on your knees. October’s already concerning outflow of US$25.8 billion worsened, underscoring Beijing’s struggles to stabilise financial markets amidst global liquidity constraints and weakening investor confidence.

CrossBorder Capital’s latest liquidity update shows that while most of the world’s central banks are easing monetary policy, China’s economic problems remain unresolved with policymakers juggling trying to support a fragile economy, while also stabilising the yuan.

Declining Bond Yields

Chinese bond markets reflect deep investor pessimism, with the 10-year sovereign bond yield plummeting to a historic low of 1.7%. This decline signals mounting concerns over the country’s economic recovery prospects for 2025 and reflects deflationary pressures undermining investor sentiment. To be clear, we’ve seen low yields before but it’s the speed of the plunge that is getting the more astute analysts concerned that this is ‘disorderly’ and portends trouble ahead.

The fall in bond yields contrasts sharply with the more optimistic outlook in China’s equity markets, painting a divided picture of the economy. While stocks remain high, bonds signal caution, and the aforementioned speed of that move is an outright concern. Adding to these concerns, CrossBorder Capital’s research suggests with deflationary pressures weighing on bond yields and global capital increasingly flowing to the U.S, China finds itself at the centre of a liquidity squeeze, which could further exacerbate its economic slowdown and more importantly present a global contagion event.

Economic Challenges

The Chinese economy faces a mix of challenges including a property sector crisis with many developers unable to recover from years of unsustainable debt accumulation, persistent deflation caused by overcapacity and weak demand, and sluggish consumer spending weighed down by rising unemployment and household debt. These issues create fragile growth and rising uncertainty, with China’s struggles slowing economic activity across Europe and Asia. For us in Australia that presents a major potential drag on our economy. Furthermore, should contagion see another global financial crisis unfold, our ticket out of the GFC (China building all those houses for no one and bridges to nowhere using our resources), will clearly not be there this time.

Government Response

In response to mounting pressures, Chinese leaders have promised to implement more vigorous fiscal and monetary policies to restore stability and confidence by lowering interest rates, increasing fiscal spending through new bond issuance to stimulate infrastructure projects and domestic consumption, and introducing long-term government bonds to fund growth initiatives and support cash-strapped local governments.

Despite these plans, policymakers remain constrained by rising debt levels and the need to maintain currency stability amidst a strong U.S. dollar. Investors remain unconvinced that the government’s response will be enough to counteract structural weaknesses or address growing liquidity concerns.

A Market Under Pressure

China’s bond market crash reflects broader economic anxieties and global liquidity shifts. Record capital outflows, declining bond yields, and structural economic challenges underscore the growing difficulties China faces in stabilising the economy. Despite government pledges to deliver fiscal and monetary support, Chinese investors remain cautious amid persistent deflation and the ongoing property crisis.

What next?

Where this goes and how far it goes is uncertain. Simplistically there are two routes. Contagion plays out and China is the straw that breaks this debt-burdened global financial system’s back, and a global financial crisis plays out. Alternatively, there is the seemingly inevitable globally coordinated (or at least coincident) unleashing of a bazooka of new liquidity (money printing by some fancy name or acronym) to prevent that collapse.

Gold uniquely wears two hats for investors. As the world’s most trusted safe haven asset, it becomes the go-to in a collapse. As one of the best correlated with global liquidity, it surges with that bazooka of liquidity. Each way bets are rare but that is what this looks like now.