Economic growth in China is slowing, reflected in falling bond yields. The June trade numbers sustain the theme of a robust trade surplus, but also show slowing export and import growth. Not helping the growth outlook is the tightening in financial conditions brought about by a stronger yuan.
The slowing theme was supported by the move to cut interest rates by the Chinese central bank for the first time since the pandemic began last year. The decision frees up 1 trillion yuan of funds banks parked at the central bank, allowing them to lend more. Meanwhile, the credit data surprised to the upside, suggesting the policy bias has shifted more towards supporting growth.
Chart 9: China 10-year bond yield (%)
Near-term growth concerns have already dented longer-term inflation expectations. But if the market sees U.S. growth prospects diminishing enough over the longer-term to keep the Federal Reserve on hold indefinitely, it will strip out more future rate hike expectations. The result will be an even flatter U.S. curve.
As financial institutions benefit from a steeper yield curve, that is the sector most vulnerable to flattening.
Chart 10: US 2-10yr yield curve flattening (bpts)
Inflation expectations, as measured by the 5-year 5-year forward breakevens, are hovering near the lowest level since March.
This bears watching as it demonstrates near-term concerns about the delta variant and economic slowing are having an impact on longer-term inflation expectations.
Inflation expectations peaked in May near 2.40%. We are now at 2.07%.
Chart 11: Inflation expectations fall: 5y5y forward breakeven.