China’s bond rally has one collateral damage

Shuli Ren, Bloomberg

A global selloff in government bonds is igniting concerns over higher mortgage repayments and corporate financing costs. While China is an outlier to this trend, lower-rates-for-longer may not necessarily be good news, either.

China is injecting billions of dollars into its largest banks and insurers. The question is why now and what the government plans to do with that money.

There’s speculation that with banks having more of a capital buffer, Beijing is finally trying to speed up bad-debt recognition and stabilize the property sector, which has been mired in a five-year downturn. After all, this capitalization plan comes only days after the government announced a major overhaul of the way homes are sold.

Some might also argue it’s yet another sign that monetary conditions in China will get easier. In July, the People’s Bank of China made its largest injection of medium-term funds into the economy since February. Liquidity has also been ample in the money market.

Most likely, given the modest scale of this capitalization program, it’s a recognition from policymakers that China’s low-rate regime is here to stay. The 10-year yield has been trading below 2% since the end of 2024 and fallen another 18 basis points this year, squeezing margins and putting pressure on the country’s financial institutions.

Recapitalizing banks is nothing new. At the annual gathering of the legislature in early March, the government said it planned to sell 300 billion yuan ($45 billion) in special sovereign bonds to replenish the capital of major state-owned banks, following a larger program announced in 2025.

What’s more unexpected is that the biggest insurance companies are also getting capitalized; more than 20% of the sovereign bond proceeds will go to the sector. So why are the likes of People’s Insurance Company (Group) of China Ltd. and China Life Insurance getting their coffers replenished even though the sector’s solvency ratio, while falling, is still well-above regulatory requirements?

About half of the industry’s total investments are in bond holdings, according to Bloomberg Intelligence analyst Steven Lam. But with Chinese sovereign yields declining, insurers are struggling to earn enough returns to honor the rates credited to policymakers. This issue is all the more pressing for the big life insurers because they have to buy long-dated government debt to match their liability needs. Their profitability is pressured, while solvency ratios are rising, increasing the need for more capital.

Of course, insurers could beef up their stock and fund investments. But these assets expose their earnings to wild swings in equity markets. Even though stock investments’ capital charges have been eased, they are still much higher than those of government debt, which regulators consider to have zero risk.

The fact that China’s biggest banks and insurers are getting a mini bailout shows that historically low bond yields are also creating financial problems. While US Treasury Secretary Scott Bessent is complaining that his financing costs are too high, his Chinese counterpart faces the opposite issue: having to borrow money to capitalize the insurers and shore up their balance sheets.

The public bond market is a fair mirror. It punishes government for a lack of fiscal discipline, but it also exposes those that allow deflationary pressures to fester. As China is discovering, even a bond rally can inflict collateral damage.

Courtesy Bloomberg/Shuli Ren