How might the simultaneous rise in US and Japanese bond yields transmit to the Chinese market? GF Securities points out three scenarios:
1. Trading on the logic of a ‘weak dollar + fiscal expansion’.
If the extreme performance of short-term US debt is temporarily slowed down, and Japan continues to maintain its interest rate hike expectations for the year, this mechanism may be triggered again. 3. Scenario three: Trading on the logic of ‘Rise of the East and Fall of the West + US Treasury spillover funds flowing to China’. Carry trade funds may not directly purchase Japanese bonds upon returning but may turn to assets with higher returns or greater risk-avoidance value. However, the independent performance of Hong Kong stocks needs to be based on a significantly improved expectation of fundamentals. Report main text 1. How does the surge in overseas long-term interest rates affect the Hong Kong stock market? (i) US bond market: Short-term supply pressure and long-term narratives On May 21, the weak demand for the US 20-year Treasury auction led to a surge in the yields of 20 and 30-year US Treasuries, causing a triple kill in US stocks, bonds, and currency, affecting global equity markets. The market is concerned that in the second and third quarters, US Treasury rates may trend upwards under the pressure of maturity repayment and foreign reduction, leading to greater fluctuations in equity markets. In terms of pricing mechanisms, there are three factors in interest rate pricing: expectations of short-term real interest rates (depending on expectations of economic growth or monetary policy paths), inflation expectations (long-term economic inflation expectations), and term premiums (compensation for future risks, including macro policies, bond supply, etc.). Over the past two years, the rise in US Treasury rates has been influenced by factors at different levels. For example: (1) The rise in US Treasury rates in 2023Q3 was mainly affected by bond supply and demand (a surge in bond issuance, Fed QT) and the rise in real interest rates; (2) The rise in US Treasury rates in 2024Q1 was mainly affected by the unexpected scale of bond issuance in Q1 and reflation concerns; (3) From 2024Q3 to Q4, it was mainly affected by the cooling of recession trades and the rise in inflation expectations. In this round of US Treasury rate increases, the rise in long-term rates is greater than that of short-term rates. Under the impact of tariffs in April, US Treasury rates actually rose, pricing term premiums and inflation expectations, which is the debt issue, Trump’s tariffs, and the liquidity impact of foreign reduction. Since May, it has been more about pricing subsequent bond supply and demand contradictions, on the one hand, foreign reduction, on the other hand, Q3 supply disturbances, and also affected by the resilience of short-term fundamentals, the Fed’s hawkish stance, and the continuous downward revision of rate cut expectations. Objectively speaking, these factors are all easily driven by news, even turning long-term narratives into short-term ones, such as the current trade war’s impact on inflation, the decline of the dollar’s hegemony, and the US Treasury sell-off, the significant expansion of deficit scale brought by Trump’s tax cut plan, etc. Looking forward, the trend of US Treasury rates mainly focuses on: first, changes in short-term fundamentals and rate cut expectations; second, bond supply disturbances around Q3; and third, the long-term narrative of the US debt issue.
Firstly, the game between fundamentals and expectations of interest rate cuts. Considering the pressure from tariffs on the United States will gradually manifest, the fundamentals do not support a long-term high-interest rate constraint. Currently, the market only prices in a pace of 1-2 interest rate cuts within the year, and there is limited room for further revision of interest rate cut expectations.
In the short term, the upward space for US Treasury rates is also relatively limited. Secondly, from the perspective of bond supply, there is indeed a supply pressure for bonds around Q3, which may increase the volatility of US Treasury rates, and thus attention should be paid to Fed actions. After the current US Treasury maturities, the main method is through the rolling renewal of short-term debt (the ‘rolling’ peak). After the debt ceiling is resolved in Q3, there will be a surge in short-term debt issuance and the Treasury’s need to replenish the TGA account; additionally, after Trump’s tax cuts are implemented, the Treasury may issue more medium to long-term debt. At that time, US Treasury rates will face certain pressures, but theoretically, the Federal Reserve has a large policy hedging space. Lastly, the long-term narrative of the US debt issue must eventually return to fundamentals. Concerns about the US government’s debt problem and fiscal sustainability are another factor currently pricing in the demand shock for US Treasuries (liquidity impact of foreign reduction). However, data shows that the US government’s leverage ratio is about 112% (end of 2023 data), which is basically in line with the average level of developed economies (107%). Essentially, the debt of developed countries is still a way of borrowing new to repay old, with continuous rolling renewal. Unless bipartisanship leads to the debt ceiling issue remaining unresolved for a long time, there is no need to short-termize long-term uncertainties; the trend of US Treasuries will ultimately return to a fundamental judgment. (II) Japanese Bond Market: Long-term Interest Rates Hit Record Highs Last week, Japanese ultra-long-term bond interest rates soared significantly, with the 30-year Japanese government bond yield rising from 2.6% at the beginning of April to 3.14% (May 21), setting a record since its issuance in 1999; the 40-year Japanese government bond yield broke through 3.6%. The 10-year and 20-year Japanese government bond yields also rose synchronously, but not as much as the ultra-long-term bonds. On May 21, the spread between the 30-year and 10-year Japanese government bonds reached 1.45%, also the highest level since its issuance in 1999. The short-term trigger for the surge in Japanese bond interest rates was, first, in response to the impact of US tariffs in April, the Japanese government began to coordinate the drafting of the supplementary budget for the fiscal year 2025, which included a large-scale tax cut + cash distribution plan, leading to a significant increase in bond issuance expectations. Second, on May 20, the auction market was cold, with the bid multiple for the 20-year Japanese government bond auction at only 2.5 times (the lowest since 2012), and the tail difference (the gap between the average price and the lowest accepted price) reached 1.14, a new high since 1987. Looking back at history, the rapid downward trend of the Japanese interest rate center/low-interest rate era has lasted for more than 30 years.Several key periods are highlighted: (1) From 1991 to 1995, the discount rate was lowered nine times consecutively, totaling a decrease of 550 basis points; in 1995, a small boom in the Japanese real estate market led to a temporary halt in monetary policy easing. (2) In 1999, the concept of ‘zero interest rates’ was introduced, which was exited in 2000; however, with intensifying deflationary pressures, quantitative easing was introduced in March 2001, bringing the policy target interest rate back to 0%.
Between 2003 and 2006, Japan’s economy, inflation, and stock market showed significant recovery, and the zero interest rate policy was exited in July 2006. (3) After the financial crisis, Japan developed a more aggressive monetary policy paradigm. In December 2008, zero interest rates were reintroduced; after Shinzo Abe took office at the end of 2012, a series of expansionary policies were quickly implemented, and in 2013, the unprecedented ‘QQE (Quantitative and Qualitative Monetary Easing)’ was launched; in 2016, a nominal negative interest rate was initiated, aiming for a 2% inflation target. Therefore, the operations of the Bank of Japan before 2024 can be summarized as: through negative interest rate policy (2016-2024), YCC (Yield Curve Control) directly controls short-term and long-term interest rates, suppressing real interest rates to stimulate inflation expectations. Specifically, under the QQE framework, the central bank continues to purchase government bonds, ETFs, and other assets, expanding the base money supply, aiming to form a transmission chain of ‘loose money → low interest rates → improved corporate financing → increased household income → expansion of consumption → inflation recovery’. The recent upward steepening of Japanese government bond yields began in 2022 and has been supported by inflation data over the past two years. Japan’s core inflation rate for 2022-2024 was 2.3%, 3.1%, and 2.5%, respectively, staying above the inflation target level for three consecutive years. Against this backdrop, Japan’s monetary policy has shifted direction: (1) In December 2022, the Bank of Japan unexpectedly adjusted the yield curve control (YCC), expanding the target level of the fluctuation range for 10-year Japanese government bond yields from ±0. 25% to ±0.5%. (2) In the second half of 2023, the Bank of Japan hinted more than once that it would soon end negative interest rates. (3) In March 2024, the negative interest rate was officially exited, and the yield curve control (YCC) policy was abolished. (4) In July 2024, the target policy interest rate was raised from the 0-0.1% range to 0.25%, and a specific plan to reduce bond purchases was announced, reducing monthly bond purchases by 40 billion yen each quarter. (5) In January 2025, the interest rate was raised again, and it was stated that if the economic, price, and market conditions meet expectations, further rate hikes would continue.From a mid-term market perspective, aside from the rebound in inflation data and the cooling bond market, the labor shortage in the employment market also warrants attention. Currently, Japan’s unemployment rate is at its lowest since 1995, while the job offer ratio (new job offers/new job applications) is at a historical high. Amid this labor shortage, in the 2025 Japanese ‘Shunto’ wage negotiations, Japanese companies agreed to an average wage increase of 5.46% for workers, marking the highest raise in 33 years. Under the ‘wage-inflation’ spiral, the Bank of Japan still has room to raise interest rates within the year.
U.S. and Japanese bonds rise together, potentially affecting the Chinese market in two ways: 1. Scenario one: Trading on the ‘weak dollar + fiscal expansion’ logic points to a strong equity market. We have analyzed the performance of global equity assets during periods of a weak U.S. dollar index since the 1970s, and most phases show a resonance in rising prices. The reason is that in a weak dollar environment, non-American currencies and assets become more attractive, driving international capital to emerging markets. At the same time, this year, countries including the U.S. and Europe have announced or foreshadowed fiscal expansion plans, which may alleviate concerns about a further global economic downturn. However, this logic is currently being severely impacted by the bond market, and the outlook faces significant uncertainty. 2. Scenario two: Trading on the ‘weak dollar, carry trade unwinding + global liquidity withdrawal’ logic is not favorable for the equity market. Over the past three years, at least four instances of Japanese bond yield spikes/carry trade unwinding have occurred: (1) In December 2022, as U.S. Treasury yields fell and the Bank of Japan unexpectedly adjusted its YCC policy, triggering a wave of Japanese bond selling; (2) At the end of 2023 and the beginning of 2024, as U. S. Treasury yields fell and the Bank of Japan hinted at exiting negative interest rates; (3) Between May and August 2024, as expectations of a U.S. recession and interest rate cuts increased, but during this period, the Bank of Japan raised interest rates twice, pushing the carry trade unwinding to a climax in the third quarter of 2024; (4) At the beginning of 2025, as U.S. recession expectations resurfaced, the Bank of Japan raised interest rates again. In these four instances of Japanese bond yields rising, combined with the narrowing of the U.S.-Japan interest rate differential, the Chinese market performed poorly. The main logic is the global carry trade unwinding, that is, the reverse trade of positions financing in yen and buying U.S. assets, prompting capital to flow back to the yen and potentially forming a ‘unwinding → yen appreciation → further unwinding’ feedback mechanism, which also implies a tightening of global liquidity. In recent market trends, due to the pressure of U.S. Treasury supply raising U.S. Treasury yields, the downward trend of the U.S.-Japan interest rate differential is not too significant. If the extreme performance of U.S. Treasury bonds in the short term is temporarily eased, and Japan continues to maintain its expectation of raising interest rates within the year, this mechanism may be triggered again.3. Scenario Three: The ‘East Rise West Fall + US Treasury Bond Outflow to China’ carry trade logic, which often involves high leverage operations such as borrowing in yen to buy US Treasuries, requires traders to close positions and cut losses when the US-Japan interest rate differential narrows. The repatriation of funds must first consider repaying yen liabilities, leading to a surge in short-term yen demand and currency appreciation.
However, the returning funds may not directly purchase Japanese bonds; they could also shift towards assets with higher expected returns (such as emerging markets) or assets with higher safe-haven value (such as gold ETFs). The Hong Kong stock market, with relatively low absolute valuations, is an option for capital repatriation, but this choice is inevitably based on the prosperity and profit effect of the Chinese market. In our March report ‘The Independent Market Trend of Hong Kong Stocks Relative to US Stocks Over the Past 15 Years,’ we have combed through the historical data, showing that the independent market trend of Hong Kong stocks relative to US stocks is not common historically. When it occurs, it is often seen when the US exhibits signs of stagflation or quasi-stagflation, while the Chinese economic fundamentals are expected to improve significantly—this improvement can be based on traditional cycles or based on the global comparative advantage of industries (such as this year’s artificial intelligence and innovative drug trends). From the high-frequency data of the second quarter, without unexpected fiscal expansion, the upward elasticity of traditional cycles may be limited. Therefore, if the logic of global capital increasing allocation to the Chinese market is played out, the market may be pushed towards a strong structural trend again. II. Global Capital Flows This Week (1) A/H Stock Market 1. Regarding the A/H interconnectivity, the average daily transaction volume of northbound funds decreased this week. This week (May 19th – May 23rd), the total transaction amount of northbound funds was 0.63 trillion yuan, with an average daily transaction amount of 15.93 billion yuan, a decrease of 2.31 billion yuan compared to last week’s average daily transaction amount. Southbound funds saw a significant net inflow this week. This week (May 19th – May 23rd), the net inflow of southbound funds was 18.95 billion Hong Kong dollars, compared to a net outflow of 8.68 billion Hong Kong dollars last week. At the individual stock level, the top net purchase amounts of southbound funds included China Construction Bank (net purchase of 5.72 billion Hong Kong dollars), Meituan-W (net purchase of 3.625 billion Hong Kong dollars), and China Mobile (net purchase of 2. 249 billion Hong Kong dollars); the top net sale amounts included Tencent Holdings (net sale of 7.671 billion Hong Kong dollars), and Tracker Fund of Hong Kong (net sale of 3.165 billion Hong Kong dollars). 2. Regarding foreign capital flows: Active foreign capital outflows decelerated, while passive foreign capital turned into outflows for A-shares and H-shares. Active foreign capital outflows from A-shares decreased, and passive foreign capital turned into outflows. As of this Wednesday (May 15th – May 21st), active foreign capital outflows from A-shares were 140 million USD (a decrease from 270 million USD last week), and passive foreign capital outflows were 120 million USD.$500 million (a reversal from last week’s inflow of $630 million); H-shares saw active foreign capital outflow of $0.06 billion, a decrease from last week’s outflow of $0.08 billion, and passive foreign capital outflow of $0.21 billion (a reversal from last week’s inflow of $0.55 billion).
Overseas important markets: 1. US stock market capital flows: Active capital in US stocks has turned into outflow, while passive capital has seen a significant outflow. As of this Wednesday (May 15th – May 21st), active capital outflow from US stocks was $510 million, a reversal from last week’s inflow of $2.48 billion; passive capital outflow was $130 million, a reversal from last week’s inflow of $1. 71 billion. 2. Other important market capital flows: Significant outflow from Japan, slight inflow into developed European markets. This week, there was a significant outflow from the Japanese market, with a reduced scale of inflow into developed European markets. Specifically, the Japanese market saw an outflow of $3.99 billion this week, compared to an inflow of $0.80 billion last week; developed European markets saw an inflow of $0. 37 billion this week, compared to an inflow of $2.72 billion last week. Other major asset classes: This week, the scale of capital outflow from gold increased, while the cryptocurrency sector maintained inflow. As of this Wednesday (May 15th – May 21st), net capital outflow from gold was $2.92 billion, a significant rise from last week’s outflow of $0.43 billion. Cryptocurrency assets saw a weekly net capital inflow of $2.34 billion, a noticeable increase from last week’s inflow of $0.89 billion. Risk warning and disclaimer: The market is risky, and investment should be approached with caution. This article does not constitute personal investment advice and has not taken into account individual users’ specific investment objectives, financial conditions, or needs. Users should consider whether any opinions, views, or conclusions in this article are suitable for their particular circumstances. Responsibility for investment decisions based on this article is assumed by the investor.