January 2, 2025

QuickTakes

The Great (Yield) Fall Of China

Today's Wall Street Journal reports: "Now, as Trump prepares for his second administration, American companies have largely gone silent about the importance of the U.S.-China relationship. That is because American businesses no longer see China as the land of opportunity. The promise of China’s market has faded as its once-booming economy hits trouble."

We've been saying for a while that China is uninvestable. That's still our view. And it is corroborated by the recent freefall in yields in China (chart). In the December 26 QT, we noted that the Chinese government was getting set to launch a series of fiscal measures to stimulate the economy within the next few months. We were skeptical that they would do much to revive the flagging Chinese economy. So are the fixed-income markets, where record-low yields are signaling that China's economy may be on the road to deflating the global economy.

From 2006 through 2021, the Chinese 10-year government bond yield was highly correlated with the price of copper (chart). They've diverged since then. The price of copper hasn't collapsed along with the Chinese bond yield because China's automakers are producing a record number of cars, accounting for a third of world auto output. They've been exporting more of them and depressing the global auto industry, especially in Germany.

The Chinese government's latest fiscal stimulus package is aimed at boosting consumer spending on durable goods by subsidizing discounts. The problem is that the property market remains depressed, weighing down consumer spending with a huge negative wealth effect. The Shenzhen Real Estate stock price index rallied late last year but is falling again despite the latest fiscal stimulus package (chart).

The price of iron ore also remains weak, suggesting that the new fiscal stimulus program might not do much to stimulate more infrastructure spending (chart). The commodity markets seem to be taking a wait-and-see attitude on the effectiveness of the latest program.

The good news is that China's official nonmanufacturing PMI jumped in December, suggesting that Chinese consumers are spending more on services (chart). The weakness in December's manufacturing PMI reflects weaker domestic demand for goods, causing more of China's production to be dumped in global markets. That’s likely to inflame protectionism among China's major export markets. The weakness in the M-PMI might also show that Chinese manufacturers are anticipating that Trump's tariffs will hit them hard. In other words, Chinese bond yields might get closer to zero.

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