Why The ‘Bond Vigilantes' Are Coming For China, Too

Forbes

2 days ago

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The People's Bank of China is having a busier-than-usual summer, and not just because of Donald Trump's tariffs.
On Friday, the team overseen by PBOC Governor Pan Gongsheng pumped at least $84 billion of short-term liquidity into mainland reverse repurchase agreements. That's code for there's deepening trouble in bond circles.
A day earlier, a sale of 30-year government bonds drew the highest yield since March, a telltale sign that investors worry about losses. The good news is that the cash the PBOC is pumping into the market has tamed things for now.
But the upward pressure on rates is not likely to go away — not with the U.S.-China trade standoff hovering over global markets at every turn. The two biggest economies just punted trade deal talks down the road — again.
Good news, it's not. Sure, the all-out, open tariff hostility is being tempered for now. But it means at least another 90 days of global markets not knowing how to hedge what's ahead. Or how to play any tariff agreement that Trump's White House announces between now and then matters, or merely tying up loose ends ahead of the bilateral deal on which 2025's economic outlook likely turns.
Chinese yields are also under upward pressure thanks to economic optimism. Asia's biggest economy is displaying impressive resilience in the face of U.S. tariffs. Though 30% is a long way from 145%, U.S. import taxes at this level are no joke. Yet China expanded 5.2% year-on-year in the second quarter.
There are signs, too, that Beijing's efforts to reduce industrial oversupply are boosting economic confidence a bit. And reducing the risk that deflation might deepen in the months ahead.
It's not that simple, of course. The so-called 'bond vigilantes' also worry that Beijing's efforts to support the economy amid tariff pain will fuel a huge increase in long-term government borrowing. This has debt traders buzzing about an increase in the budget deficit in late 2025.
Between January and June, China's broad fiscal gap widened 45% from a year earlier. It hit 5.25 trillion yuan ($732 billion). The issue is less the absolute number than the trajectory. And the ways in which economists schooled in Japan's 1990s nightmare can follow the dots as Beijing battles deflation the way Tokyo did for decades.
Again, for an $18 trillion economy, a fiscal deficit a bit smaller than Taiwan's annual gross domestic product is manageable. But along with following the dots, China watchers can connect them, too.
Take China's local governments, which are sitting on trillions of dollars in debt. Lots of it is the off-balance-sheet kind by way of local government financing vehicles (LGFVs). Transparency not being China's strong suit, it's not unreasonable to wonder if the nation's debt outlook is worse than known.
A major contributor to the problem is China's setting of GDP targets. This annual ritual incentivizes local leaders across China's 34 province-level administrative divisions to generate above-trend growth. This is the tried-and-true way local politicians rise to national prominence in Communist Party circles.
Yet it explains why China has way too many six-lane highways, low-vacancy skyscrapers, sprawling international airports struggling to win routes from airlines, white-elephant stadiums and, yes, giant apartment complexes that developers can't complete.
Never mind that Beijing's insistence on setting an annual GDP ultimatum — this year's is 'around 5%' — warps financial incentives, rewards low-quality growth and weds Beijing to unproductive development policies that treat the symptoms of the nation's troubles, not the underlying causes. China's problem is that its 1.4 billion people lack confidence in the future to save less and spend more.
All the borrowing that Beijing is doing today will do little, if anything, to repair China's cratering property sector. Only bold, creative policy moves can get these bad assets off developers' balance sheets. Nor will today's debt issuance clean up municipal finances, reduce high youth unemployment, increase productivity and transparency or address lopsided demographics as the ranks of the elderly increase and the birthrate stagnates.
The bond vigilantes bidding up Chinese government yields aren't always right. But in the second half of 2025, it's hard to argue they don't make a good point.