(Yicai) May 27 -- The global bond market is undergoing a major structural change. In the second quarter, government bond yields in developed economies have surged to levels rarely seen during peacetime. This is due to a combination of factors including unusually large fiscal deficits, cost-push inflation triggered by the energy crisis and central banks being forced to change policy direction. Meanwhile, China, the world’s second-largest economy, has seen government bond yields dip slightly and they remain far below those in developed countries. In this context, the central government should decisively and substantially increase leverage.

The speed, magnitude and synchrony of the recent rise in government bond yields in developed markets signify a profound structural shift in global capital pricing. Recently, the yield on the US 10-year treasury bond reached 4.67 percent, while the 30-year bond rose above 5.15 percent. In Germany, the 10-year government bond yield climbed to 3.19 percent, the highest level since the peak of the eurozone debt crisis in 2011. In the UK, the 30-year government bond yield advanced to 5.81 percent, a level not seen since 1998. The biggest change occurred in Japan, where the yield on the 10-year Japanese government bond surged to 2.8 percent, the highest since 1996 and signaling the end of the country’s ultra-low-interest-rate era that lasted more than 25 years.

The simultaneous rise in government bond yields in developed markets is driven by five key factors, namely persistent fiscal deficits, conflict between Japan's fiscal and monetary policies, the weakening of market stability as a result of central-bank balance-sheet reductions, the tightening of global liquidity due to the return of Japanese funds, and the combined impact of geopolitical energy shocks and the artificial intelligence investment boom.

In stark contrast to these trends, China's 10-year government bond yield has continued to slide, at one point falling to a historical low of 1.6 percent before stabilizing between 1.7 percent and 1.8 percent. This stands in stark contrast to the steady rise in yields abroad. The main reason for this divergence is the impact of the downturn in the real estate sector on both household and local government investments. Households have shifted from borrowing to buy homes to precautionary saving, leading to a large build-up of excess deposits in the banking system, much of which continues to flow into the government bond market.

Unlike Japan’s carry-trade model, China's widening onshore-offshore interest rate gap has given rise to a new "debt-driven" model of Chinese yuan internationalization based on demand from the real economy. Global issuers are able to issue offshore yuan bonds at relatively low financing costs of around 2.5 percent, replacing US dollar bonds with interest rates as high as 5.5 percent. This has triggered a surge in the issuance of both onshore Panda bonds and offshore Dim Sum bonds. In the first four months, Dim Sum bond issuance soared 25.7 percent year-on-year to CNY460.9 billion (USD67.9 billion).

However, this model depends heavily on capital controls, making it difficult for yuan internationalization to achieve a meaningful institutional breakthrough. It also creates limitations for the global expansion of Chinese companies. In addition, large amounts of domestic savings remain trapped in China, creating an "asset shortage" in a low-interest-rate environment.

Based on Japan's experience over the past few decades, the key to escaping low inflation and low interest rates is to fully utilize the current low-interest-rate environment to implement strong counter-cyclical macroeconomic policies.

The central government should decisively increase leverage. In addition to continuing support for high-tech emerging industries and strategic hard technologies, the central government should issue ultra-long-term special government bonds so as to gradually absorb and restructure the bad debts that accumulated within the financial system after the collapse of the property bubble.

At the same time, the central government should also significantly hike spending on social security, basic healthcare, inclusive pension schemes and consumer subsidies. This would help ordinary households repair their balance sheets, reduce precautionary saving and revive consumer-driven economic growth.

(The author is Lu Ting, chief China economist at Nomura Securities.)

Editor: Kim Taylor