Zheshang Securities: Rising inflation expectations have a short-term manageable impact on the domestic bond market

Key Points

The short-term impact of rising inflation expectations on the domestic bond market is likely manageable, and the current macro environment domestically and internationally appears relatively friendly to bonds. Looking ahead, the 10-year government bond yield is likely to find strong support above 1.85% and may attempt to move downward toward around 1.70%.

Inflation Expectations Rise, Short-term Impact on Domestic Bonds Is Manageable

As conflicts between the US and Iran intensify, global inflation expectations have risen again, leading to adjustments in US and Japanese bonds to varying degrees. From multiple perspectives—expectations, timing, and magnitude—we believe the short-term impact of rising inflation expectations on the domestic bond market is relatively limited.

First, there are significant differences between domestic and international inflation environments. Previously, the US and Japan experienced prolonged high inflation, whereas since 2023, China has generally maintained low inflation. Rising inflation expectations are more negative for the US and Japan, potentially slowing the Federal Reserve’s rate cuts and accelerating the Bank of Japan’s rate hikes, impacting US and Japanese bonds. However, we believe the effect on China may be more neutral or even positive. Moderate inflation increases are unlikely to hinder the easing monetary policy, and the pace of reserve requirement cuts and rate reductions remains unchanged, which could also support steady economic recovery. For the domestic bond market, rising inflation expectations are not a sudden “black swan” but more of a gradual increase from 1.0 to 1.1. By mid-2025, amid intensive anti-inflation policies and a rebound in commodity markets—such as the South China Industrial Products Index rising up to 13.02% from late May to late July—bond markets may have already begun to price in the potential impact of warming inflation. Therefore, we see current inflation expectation increases as a continuation of previous trading rather than an unexpected shock, with overall impacts being relatively predictable.

Second, the sustainability of high international oil prices remains uncertain, and there is a lag in their transmission to domestic prices. The recent rise in oil prices driven by US-Iran conflicts depends heavily on whether the Strait of Hormuz remains open. Although Iran’s UN ambassador denied reports of a blockade on social media, whether tankers dare to pass through remains uncertain. It’s also unclear whether oil prices will spike briefly or stay above $90 per barrel for an extended period. Additionally, the transmission of international oil prices to domestic prices involves a lag, so short-term domestic energy prices are unlikely to surge significantly.

Third, energy’s weight in the Consumer Price Index (CPI) is relatively low, so even sustained high oil prices would have limited impact on CPI. For example, in January, energy prices fell by 5.0%, reducing CPI year-on-year by about 0.34 percentage points, indicating energy’s weight in CPI is approximately 6.8%. Energy includes more than just oil; in January, domestic oil prices fell by about 14.2%, while energy prices overall declined by only 5.0%. Conversely, rising oil prices would have a limited effect on energy’s contribution. Moreover, pork prices, a major factor influencing CPI, remain under high base effects, and prices for eggs and vegetables are unlikely to rebound quickly. Thus, even if oil prices stay high, their upward pressure on CPI would be limited.

Macro Environment Is Relatively Friendly to the Current Bond Market

Various signs suggest that investors are not fully prepared for a prolonged or widespread escalation of US-Iran conflicts. Although the current conflict is more intense than the “12-Day War” of 2025, financial markets have not priced in long-term disruptions; most investors seem to be basing expectations on short-term, localized conflict scenarios. US and Japanese stock markets have recently experienced corrections but are showing signs of steady recovery. Compared to the panic during the Russia-Ukraine conflict in 2022, market sentiment remains calmer, with the VIX index indicating less fear. International oil prices spiked to around $90 per barrel but did not reach $100, reflecting that markets have not fully priced in a long-term supply disruption. The dominant narrative in the market currently centers on inflation rather than safe-haven assets; for instance, gold prices even briefly fell below $5,000 per ounce on March 3. For China’s bond market, rising inflation expectations are not the main concern; rather, the potential escalation or long-term nature of conflicts could trigger renewed safe-haven demand. If the conflict intensifies further, it may lead investors to reassess and adjust their baseline expectations, creating a more favorable external environment for bonds.

The People’s Bank of China’s stance on liquidity support appears relatively clear. Since early 2026, the central bank has continuously increased liquidity injections, creating a relatively ample funding environment. Low borrowing costs help stabilize the bond market and mitigate downside risks. Looking ahead, the government’s work report reiterates the flexible and efficient use of tools like reserve requirement ratio (RRR) cuts and interest rate reductions to maintain ample liquidity, suggesting potential easing measures remain possible. We believe that before actual implementation of RRR or rate cuts, the bond market can continue to trade along the broad monetary easing path.

Comparing the Bond Market in the First Half of 2025 with the Current Stock Market

Expectations: Since 2024, the bond market has steadily formed a firm bullish outlook—“hold bonds, buy on dips”—with few investors doubting further declines in government bond yields before a substantial correction in 2025. In the second half of 2025, the equity market is expected to gradually enter a “slow bull” phase, with most investors optimistic about the Shanghai Composite Index reaching new highs.

Market performance: At the end of 2024 and early 2025, bonds experienced a strong cross-year rally, with the 10-year government bond yield dropping rapidly from around 2.15% in mid-November 2024 to about 1.60% in early 2025, facing resistance at that level which it failed to break after three attempts. The Shanghai Composite Index, by late 2025, saw a 17-day rally spanning the year-end, rising from 3,824.81 points in mid-December 2025 to over 4,100 points, but faced resistance around 4,200 points, with three failed attempts to surpass that level.

Looking ahead, given the ongoing geopolitical risks, we believe the stock market may experience more short-term volatility. While strong buying support could form a bottom, a breakthrough above 4,200 points may require further catalysts. The bond market appears more optimistic, with the 10-year yield likely to find strong support above 1.85% and potentially attempt to decline toward around 1.70%.

Risk Warning

Unexpected changes in macroeconomic policies could alter asset valuation logic, leading to adjustments in the bond market. Additionally, institutional behavior can be unpredictable; if large-scale coordinated actions occur and trigger negative feedback, the bond market could experience corrections.

(Source: Zheshang Securities)