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, as 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%, with potential to attempt a downward move toward around 1.70%.

Inflation Expectations Rising Are Short-Term Manageable for the Domestic Bond Market

The escalation of conflicts between the US and Iran has reignited global inflation expectations, leading to adjustments in both 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 in inflation environments domestically and abroad. Previously, the US and Japan experienced prolonged high inflation, whereas China has maintained low inflation since 2023. 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, which could impact 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, such as reserve ratio cuts or rate reductions, which remain supportive of economic recovery. For the domestic bond market, inflation expectations have not suddenly jumped from zero to one; rather, they have likely only slightly increased from 1.0 to 1.1. By mid-2025, amid intensive anti-inflation policies and a rebound in commodity markets—such as the Nanhua Industrial Products Index rising up to 13.02% during the peak of the rally from late May to late July—bond markets may have already begun to discuss and partially price in the potential impact of warming inflation. Based on this, we see current inflation expectation increases as a continuation of prior trading rather than a sudden “black swan,” with overall impact 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 on March 5, whether tankers will dare to pass through the strait 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 from international to domestic oil prices involves a lag, so short-term domestic energy prices are unlikely to see large jumps solely due to high international oil prices.

Third, energy’s weight in the CPI basket is relatively low, so even if oil prices stay high, the impact on CPI will be limited. Considering extreme scenarios where international oil prices remain high for a prolonged period, data shows that in January, energy prices fell by 5.0%, reducing CPI year-on-year by about 0.34 percentage points, with energy’s weight in CPI around 6.8%. Energy includes more than just oil; in January, domestic oil prices fell approximately 14.2%, so the overall energy price decline was only 5.0%. Conversely, rising oil prices would have a limited effect on energy’s contribution. Moreover, pork prices, a major factor influencing CPI growth, remain under high base pressure, and prices for eggs and vegetables are unlikely to rebound quickly. Therefore, even if oil prices stay high, their upward pressure on CPI will be limited.

The Macro Environment Is Relatively Favorable for Bonds

Various signs suggest that investors are not fully prepared for a prolonged or widespread escalation of US-Iran conflicts. The current conflict is more intense than the “12-Day War” of 2025, but financial markets have priced in expectations based on short-term, localized conflict. US and Japanese stock markets have recently experienced corrections but show signs of steady recovery. Compared to the spike in market panic during the Russia-Ukraine conflict in 2022, the current VIX index and market sentiment are less extreme. Although international oil prices have risen to around $90 per barrel, the Strait of Hormuz is close to a blockade, yet prices have not surged past $100, indicating 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 demand; for example, London gold prices even briefly fell below $5,000 per ounce on March 3. For the domestic 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 central bank’s stance on maintaining liquidity appears relatively clear. Since early 2026, the central bank has continuously increased liquidity, creating a relatively ample funding environment. Low borrowing costs help support the bond market and mitigate downside risks. Looking ahead, the government’s work report reiterates the flexible and efficient use of tools like reserve ratio cuts and interest rate reductions to maintain ample liquidity, leaving room for potential easing measures. We believe that before actual implementation of reserve ratio 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 of “holding bonds without speculation, buying on dips.” Before a substantial correction in 2025, almost no bond investors doubted further declines in government bond yields. In the second half of 2025, the equity market gradually adopted a “slow bull” consensus, with most investors expecting the Shanghai Composite Index to reach 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 Index, by late 2025, also 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 break through.

Looking ahead, given the ongoing high geopolitical risks, we expect the stock market to remain volatile in the short term. While strong buying support may form a bottom, a breakthrough above 4,200 points likely requires a catalyst. The bond market appears more optimistic, with the 10-year yield supported above 1.85% and potentially drifting down 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 behaviors can be unpredictable; if large-scale coordinated actions occur and trigger negative feedback, the bond market may experience corrections.

(Source: Zheshang Securities)