In a world of surging government bond yields, there is one country where yields are actually dropping. That’s China. 

Since 2023, the country’s bond yields have been falling non-stop. Last I checked, the Chinese 10-year bond yield fetches a meagre 1.66% - a full four percentage points lower than US’s.

Chart 1 shows the structural decline of the interest rates in the world’s second largest economy. 

What’s causing this sustained drop in rates?

Contracting aggregate demand is why Chinese yields are dropping across the board. While China’s headline news often relate to its trillion-dollar trade surplus or fast-expanding AI companies, dig a little deeper you’ll find its domestic undercurrents to be much rockier. 

Businesses and household aren’t queueing to borrow capital. Banks are in no hurry to lend either. Debt is cheap, but unaffordable, at the same time.

This perplexing trend is largely caused by the persistent fall in house prices. In a country where the bulk of the household wealth is tied up in property, falling real estate prices is eroding the nation’s wealth multiplier effect. 

When house prices decline, it generates two direct impact:

1. First, the collateral associated with mortgages are shrinking in value.
2. Second, many homeowners are feeling the acute economic pinch as household equity shrinks. 

Look at Vanke (ticker: 000002), formerly one of the largest property developers in China. Its share prices have collapsed by 90% in five years! Scores of other developers saw a similar trend in their share prices. (Chart 2)

Because of the shrinking wealth effect, Chinese consumer spending aren’t exactly growing. 

LVMH, one of the largest luxury fashion houses, observed this weakness in its latest quarterly result (12 Oct 2026): “The Fashion & Leather Goods business group continued to benefit from the buoyant US market but was affected in the third quarter by the slowdown in demand in China.”

Without the massive Chinese market, no wonder LVMH’s share price is struggling, as are Kering’s (KER) and Hermes’s (RMS). All three luxury stock hit 52-week lows recently and may continue to decline in the absence of downside support. (Chart 3)

Chinese Banks at Fresh Highs

But the Chinese government is not standing idle. It is proactively shoring up the balance sheets of the banking sector as deflation takes hold in the country. 

In early September, the government pumped $54 billion to re-capitalise the main financial banks and insurers, on top of the $72 billion capital injections last year. 

Moreover, the government has recently announced a mortgage subsidy program to help rejuvenate the property market. 

As a result of these measures, many Chinese banks hit new highs. The largest by market cap - China Construction Bank (939 HK, $444bn) - rose to its highest level, as did Bank of China (3988 HK). (See Chart 4)

Many investors are piling into these financials because of the government support and generous yields. CCB, for example, registers a dividend yield of more than 3.4% even after a strong run in share prices. This is better than the yields offered by government bonds.

Still, when a country’s economic trend is deflationary the downside risks multiply. Real growth will be hard to come by.

And the investment environment is not wholly bullish too. Many recent IPOs have fallen hard, such as Yushu Technology (688836). 

CXMT (688825), one of the largest chip companies worth US$500bn, has flatlined after its public listing. 

In addition to subdue corporate earnings, the global economy is entering into a choppy period due to high energy prices and rising interest rates. A synchronised slowdown will hit China’s immense exports.

There may be pockets of growth in the Chinese equity sector, but they are policy driven.

In sum, investors with exposure to the Chinese economy (LSE-listed stocks like FCSS, HSBC, STAN, or US-listed BABA, PDD) should be aware of the country's deflationary risk. Stoploss must be respected as no one can predict when this economic trend will turn around.