Marcella Chow

Macroscope | As US government bonds surge, it’s a different story for China and Japan

Bonds yields have fallen in China and barely risen in Japan on looser monetary policy. But even the rest of Asia is growing less sensitive to the sway of Treasuries

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While most developed markets and Asian central banks have been tightening financial conditions, the People’s Bank of China has cut key interest rates and reserve requirement ratios for banks. Photo: Reuters

Marcella Chow

Published: 8:30pm, 27 Oct 2023

Since the expansive post-Covid-19 reopening, central banks across the globe have been grappling with inflation underpinned by both pent-up demand and supply disruptions. While we have witnessed arguably the most aggressive monetary tightening cycles since the Great Inflation of the 1970s, markets seem divided on whether the latest cycle of interest rate increases is reaching its conclusion.

Inflation is moving in the right direction but uncertainties around energy prices as a result of the conflict in the Middle East and the continued hawkish central bank messaging have prompted markets to price in a “prolonged higher for longer” scenario, particularly for the US Federal Reserve.

Against elevated inflationary price pressures, long-term US government bond yields have increased sharply, and have started to include higher “term premiums” – the compensation investors expect to bear for the risk of holding longer-term debt. Still, the risk regarding the direction of bond yields is somewhat balanced at this point, and contingent on the Fed’s near-term outlook.

Asian bond yields used to move in sync with US bond yields but the correlation has loosened over the years. The 12-month rolling correlation rate has fallen from 0.91 at the end of 2021 to 0.52 last month. This can be attributed in part to Asia’s financial sector being increasingly intermediated through the banking system rather than the capital markets.

Another possible reason is that the monetary tightening cycle in Asia is less assertive than in other regions such as Latin America. This decline in Asia’s sensitivity to US rates has been broadly positive for banks’ balance sheets.

But the narrative around bonds yields in China and Japan are a different story altogether.