China-US yield gap nears record high as US treasury sell-off deepens

A fresh selloff in Treasuries has pushed the yield gap between US and Chinese 10-year bonds back toward an all-time high, raising the risk of capital outflow from the Asian nation.

The benchmark 10-year Treasury yield inched as high as 4.81% in Asian trading on Wednesday, its highest level in nearly three years, while Chinese yields of a similar tenor held steady at 1.69%. That widened the yield spread between the two nations to 312 basis points, approaching the record high of roughly 315 basis points set early last year, according to Bloomberg data dating back to 2002.

The widening spread reflects starkly contrasting monetary policy paths: the Federal Reserve is under pressure to raise interest rates to combat persistent inflation, while the People’s Bank of China has kept borrowing costs low to stimulate recovery.

While this widening rate gap theoretically diminishes the appeal of Chinese assets and raises the threat of capital flight, some analysts note that the real-world fallout is being cushioned by domestic market buffers.

“The wide US-China interest rate gap across the curve, alongside a relatively flat China curve, will continue to weigh on the attractiveness of China bonds for foreign private-sector investors, partially offsetting the benefits from a gradual yuan appreciation,” said Jeffrey Zhang, a strategist at Credit Agricole CIB.

Despite those headwinds, Zhang downplayed the threat of rapid capital flight, citing China’s well-anchored fiscal and monetary policies. He expects reserve managers to maintain interest in Chinese government bonds for asset diversification and the growing international use of the yuan.

He added that a boom in the Panda bond market — yuan-denominated bonds issued in China by foreign borrowers — will also help lure new types of global investors into local credit markets.

Beyond bond market dynamics, the widening US-China yield gap has had little impact on the yuan, which traded little changed at 6.72 per dollar on Wednesday, lingering near the strongest level since early 2023.

The yuan has gained nearly 4% this year, making it Asia’s second-best performer behind the South Korean won on the back of robust Chinese exports and corporate currency conversions. Strict capital controls limit disorderly outflows, while low foreign exposure in local bonds helps cushion the market from surging US yields.

Foreign funds’ holdings of Chinese government bonds have declined since 2022, accounting for just 4.6% of the total market as of the end of July, according to Bloomberg calculations.

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