China bonds rally with yields hitting record lows after PBOC signals more easing to boost growth

China bonds rallied with yields hitting record lows after the People's Bank of China on Tuesday announced that it would cut the reserve requirement ratio for banks, and also reduce the reverse repo rate.

Yield on China's 10-year government bonds fell 3.2 basis points to 2.041%, data from LSEG showed, marking a record low. 30-year bond yields dropped 0.4 basis points to a record low of 2.168%.

"Yields declined due to larger-than-expected PBOC easing. The 20bp cut to 7-day reverse repo rate is the largest since the Covid crisis. While commendable, it is no big bang rate cut," said Winson Phoon, Maybank's head of fixed income research.

"Growth outlook should receive a near-term boost to sentiment, but what really matters is a sustainable recovery in the medium term, which remains unclear," he added.

PBOC Governor Pan Gongsheng announced at a press conference that China will be reducing the reserve requirement ratio or the amount of cash banks must hold by 50 basis points.

China's onshore yuan weakened to 7.06 against the dollar, according to data from LSEG. 

This sudden high-level press conference was arranged following last week's interest rate cut by the U.S. Federal Reserve, which initiated an easing cycle that may allow China's central bank to lower its rates further to stimulate growth amid deflationary pressures.

In recent months, insurance companies and institutional investors have flocked to China's bond market, partly due to limited investment opportunities available elsewhere. The real estate market has declined, and the stock market has had difficulty bouncing back from several years of low performance.

China's central bank has consistently cautioned about the risks of destabilizing bubbles as investors flock to government bonds.

In July, the PBOC-affiliated "Financial News" criticized the rush to purchase Chinese government bonds, labeling the move as a form of "shorting" the economy.

"This is the only asset in China that is safe," Alicia Garcia-Herrero, chief economist for Asia Pacific at Natixis told CNBC. "The rest — credit, equity, are not safe. It is increasingly unsafe. So everybody's jumping on sovereign bonds."

Investors with excess savings are piling into bonds because there's no access to foreign assets, she added.

PBOC's Pan indicated that a 0.2-0.25% reduction in the loan prime rate was also on the table, though he did not clarify when this might happen or whether he was referring to the one-year or five-year LPR. Last Friday, the PBOC maintained its main benchmark lending rates at their current levels during the monthly fixing.

"The bond yields should go lower due to cut to the policy rate, i.e. 7-day reverse repo. In the meantime, deposit rates will be lowered which should favor bond markets as well," Hao Zhou, chief economist at Guotai Junan International told CNBC via email.