Growth remains weak, while government bond curve flattening and RMB appreciation remain the principal market themes

Overview

This weekly report examines how China's slowing growth is transmitting to RMB rates, bond flows, and exchange rates. The report believes fiscal support has not yet fully reached the real economy, but market positioning had already returned to neutral, so weaker data did not trigger significant selling. Against this backdrop, the institution prefers the relative performance of ultra-long government bonds and curve flattening, while believing offshore bond demand, corporate FX conversion, and central bank fixing signals may continue to support the RMB.

Core views

China's July data extended the growth weakness seen since the second quarter and corroborated earlier soft PMI signals. Insufficient consumption and the property downturn remain existing pressures, but the persistent weakness in investment activity is more concerning: after briefly stabilizing in June, infrastructure investment fell sharply again in July, while manufacturing fixed-asset investment showed no significant improvement. Despite increasingly growth-supportive policy rhetoric, government and local government bond issuance remains slower than in the same period last year, while policy bank bonds continue to register net redemptions year to date, indicating that fiscal and quasi-fiscal support has yet to reach the real economy meaningfully. The remaining government bond quota still leaves room for greater support in the coming months, but changes in local government leadership could result in weaker-than-expected stimulus. J.P. Morgan economists have therefore lowered their 2026 GDP growth forecast to 4.5%, at the lower end of the official target range. The market reaction was relatively muted, however, because China-related assets had already surrendered most of the optimism priced in before the data release. The institution's estimate of the market-implied China risk premium had approached neutral by the beginning of this week, indicating that positioning and sentiment had cooled in advance. The weak macro environment is generally favorable for RMB rates, although seasonal funding pressures may constrain a broad near-term rally in duration assets. Liquidity remains broadly ample but has tightened slightly since June, reflecting the central bank's more refined liquidity management in the second quarter. With economic momentum remaining subdued, the central bank has increased liquidity injections since July and raised the frequency of overnight reverse repo operations, providing supplementary liquidity during tax-payment periods and at month-end to smooth funding volatility and address financing pressures in the coming weeks. The report believes this could also gradually create the conditions for the central bank to shift its formal operating target from the current seven-day tenor to the overnight rate. Consecutive data disappointments have raised expectations of further easing, but the market sees limited scope for substantial rate cuts, while the shortest-end rates already carry a negative-carry cost, which may constrain front-end performance. By comparison, the government bond curve beyond ten years still appears too steep. The 10-year government bond yield is around 1.84%, already below the institution's model-estimated fair value, implying limited room to position solely for a sharp further decline in yields. However, the 10-year–30-year spread remains around 14bp wider than the model-implied fair value, equivalent to 1.5 standard deviations. The report therefore believes that in an environment combining soft growth, seasonal liquidity pressure, and expensive intermediate-tenor valuations, ultra-long government bonds can still outperform on a relative basis and the curve can continue to flatten. Chinese bonds have recently performed strongly amid rising global yields. RMB rates have relatively low sensitivity to volatility in major overseas markets, and together with FX gains, Chinese government bonds have delivered a total return of around 4% so far in 2026, outperforming most developed- and emerging-market local-currency bonds apart from a few high-yielding markets in Latin America and Europe, the Middle East, and Africa. Stable returns and diversification benefits have again attracted offshore investors: in July, offshore investors increased their holdings of Chinese government bonds for a third consecutive month, generating net inflows of around US$1.4 billion, though below the second-quarter monthly average of US$3.0 billion. CFETS flow data without maturity adjustments show that purchases through CIBM accounts, which are more representative of medium- and long-term institutional investors, have reached their strongest level since 2025. Since the hedged yield advantage has not improved materially, the report judges that incremental demand may be coming primarily from unhedged positions, making bond inflows more directly supportive of the RMB. Onshore investors' demand for offshore bonds has also strengthened following regulatory easing. After Southbound Bond Connect was expanded to non-bank financial institutions last year, regulators further increased the southbound quota from RMB500 billion to RMB800 billion. Quota utilization has continued to rise, and cumulative southbound flows so far in 2026 have already exceeded the full-year total for 2025. This provides demand support for the rapidly expanding dim sum bond market. China's persistently low inflation and accommodative monetary policy make RMB funding costs more attractive relative to offshore markets, prompting increased dim sum bond issuance by non-Chinese borrowers. Such borrowers account for 24% of issuance so far in 2026, up from 19% in 2016. In FX, despite disappointing economic data, broad US dollar weakness pushed USD/CNH into a lower range, with spot briefly reaching the area around 6.72 this week. However, the RMB's response to the dollar's decline was limited, and the RMB trade-weighted index fell to its lowest level since June. SAFE data show that Chinese corporate dollar selling weakened in July, with the gross-to-net FX settlement ratio falling to a multiyear low after remaining above seasonal levels for several consecutive months. The RMB has a structurally negative interest-rate differential, so over the past year, whether corporates converted dollars into RMB has increasingly depended on the RMB's total return. The RMB's total return was negative in June, and together with a slower pace of appreciation in the daily fixing, this discouraged FX conversion in July. The recent break in USD/CNH below its previous range and the return of positive RMB total returns could revive corporate dollar selling. The report emphasizes that these flows could create a positive feedback loop: improved RMB returns encourage conversion, and conversion in turn supports further RMB appreciation. The central bank is still managing the pace of RMB appreciation, as indicated by the sizable gap between the spot rate and the fixing. However, the weak-RMB bias embedded in the fixing relative to J.P. Morgan's estimate has diminished in recent weeks, suggesting that the central bank's resistance to RMB appreciation is easing at the margin and that a fixing below 6.78 is now possible. The report reiterates that the recent stabilization of the fixing looks more like a temporary application of the brakes than the central bank imposing a hard ceiling on further RMB appreciation. With the market focused on President Xi Jinping's upcoming visit to the US, the risk remains tilted toward the central bank resuming a clearer pro-RMB fixing signal. Following yen intervention and steepening of the US yield curve, J.P. Morgan's global FX team has shifted to a neutral view on the US dollar index. With the dollar no longer clearly biased stronger, its year-end USD/CNY forecast of 6.70 faces further downside risk, meaning the RMB could be stronger than forecast. Finally, the report revisits the debate over RMB valuation. The RMB real effective exchange rate adjusted by CPI and PPI has fallen around 15%–20% from its 2022 peak, which is often cited as evidence that the RMB is materially undervalued. Yet the RMB nominal effective exchange rate has actually appreciated by more than 5% over the same period, indicating broad nominal RMB strength rather than depreciation. The clear divergence between the NEER and REER indicates that the decline in the REER primarily reflects China's unusually low inflation relative to the rest of the world and cannot be attributed entirely to nominal exchange-rate policy. In Asia, the RMB's nominal effective exchange rate against many regional currencies has also appreciated, while some bilateral real exchange rates have strengthened despite large inflation differentials. Therefore, a single explanation centered on sacrificing neighboring countries' competitiveness through a weak exchange rate is insufficient. The report advocates understanding valuation from a general-equilibrium perspective involving divergences in growth, inflation, and macroeconomic cycles between China and the rest of the world. The key question is not simply whether the REER has overshot, but through which channel the gap will converge. The institution still believes the central bank is willing over the longer term to promote gradual, controlled nominal RMB appreciation, but its motivation is more closely related to RMB internationalization, encouraging corporate dollar conversion, and developing the offshore RMB market than specifically correcting supposed REER undervaluation.

Analysis framework

The report first assesses growth momentum using consumption, property, infrastructure, and manufacturing investment data, and then examines government, local government, and policy bank bond issuance to determine whether fiscal support is reaching the real economy. It subsequently combines macro fundamentals, seasonal liquidity patterns, central bank operations, and model-implied fair values to compare relative opportunities across government bond curve tenors, before analyzing flows using offshore holdings, CIBM accounts, Southbound Bond Connect, and dim sum bond issuance. The FX section connects corporate conversion, RMB total returns, and central bank fixing signals, and finally reframes the RMB valuation issue by decomposing the NEER, REER, and inflation differentials.

Methodology notes

• Fixed Income and Credit AnalysisYield curve analysis

  Comparison of the government bond yield curve with model-implied fair value

  The report separately compares the 10-year government bond yield and the 10-year–30-year spread with model-implied fair levels rather than assessing only the overall direction of rates. The 10-year yield is already below fair value, but the long-end spread remains too wide, leading to a curve-flattening conclusion.

• Event-Driven Strategy and Behavioral FinanceFund Flow/Positioning Analysis

  Analysis of bond holdings, trading channels, and corporate FX conversion flows

  The report uses offshore government bond holdings, net purchases through CIBM accounts, Southbound Bond Connect flows, and SAFE settlement ratios to assess investor behavior and analyzes how these flows affect bond demand and the RMB exchange rate.

• Event-Driven Strategy and Behavioral FinanceExpectation Gap/Expectation Management

  Comparison of the market-implied China risk premium with economic surprises

  The report uses the market-implied risk premium to measure positioning and sentiment before data releases, arguing that assets had already priced in and subsequently surrendered optimistic expectations, resulting in a limited market reaction following the weak data.

• Macroeconomic framework

  NEER–REER decomposition and general-equilibrium exchange-rate valuation

  The report distinguishes between the nominal effective exchange rate and the inflation-adjusted real effective exchange rate, decomposing their divergence into nominal exchange-rate movements and inflation differentials to demonstrate that a decline in the REER is not equivalent to the central bank deliberately suppressing the RMB.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• Chinese Government Bonds (CGBs)

  Weak growth and central bank liquidity injections support RMB rates, and the report favors further flattening of the 10-year–30-year curve.

  Strengths

  The year-to-date total return is around 4%, sensitivity to rising rates in major global markets is relatively low, and the asset offers diversification value.

  Weaknesses

  The 10-year yield is around 1.84%, already below the model-implied fair value, limiting the scope for a further sharp decline in yields overall.

  Comparison

  Year-to-date performance has exceeded that of most developed- and emerging-market local-currency bonds apart from a few high-yielding markets in Latin America and Europe, the Middle East, and Africa.

  Risks

  Seasonal funding tightening, negative-carry costs at the front end, and limited scope for meaningful rate cuts could constrain a broad near-term rally.

• RMB (CNY/CNH)

  Bond inflows, a recovery in corporate dollar conversion, reduced central bank fixing resistance, and US dollar weakness could all support RMB appreciation.

  Strengths

  USD/CNH has entered a lower range around 6.72, RMB total returns have turned positive again, and a fixing below 6.78 is possible.

  Weaknesses

  The RMB still has a structurally negative interest-rate differential, while corporate dollar selling and the FX settlement ratio fell to multiyear lows in July.

  Comparison

  The RMB NEER has appreciated by more than 5% since 2022, in clear contrast to the approximately 15%–20% decline in the REER over the same period.

  Risks

  The central bank is still managing the pace of appreciation, and whether corporate conversion continues to recover depends on the RMB's total return.

• Offshore RMB Dim Sum Bonds

  The relaxation of Southbound Bond Connect and the RMB funding-cost advantage are simultaneously driving demand and issuance growth.

  Strengths

  The southbound quota was increased to RMB800 billion, and cumulative 2026 flows have already exceeded the full-year total for last year.

  Weaknesses

  Demand support partly depends on continued regulatory easing and persistent onshore-offshore interest-rate differentials.

  Comparison

  Non-Chinese issuers account for 24% of supply so far in 2026, up from 19% in 2016.

  Risks

  If southbound flows slow or the RMB funding-cost advantage narrows, demand and new issuance could be affected.

Key data

• 2026 China GDP growth forecast4.5%J.P. Morgan's revised forecast, at the lower end of the official target range
• 10-year Chinese government bond yieldAround 1.84%Already below the institution's model-estimated fair value
• 10-year–30-year government bond spread deviationAround 14bp or 1.5 standard deviationsWide relative to the model-implied fair value, supporting further curve flattening
• Year-to-date total return on Chinese government bondsAround 4%Includes low-rate performance and FX gains, outperforming most developed- and emerging-market local-currency bonds
• July offshore inflows into Chinese government bonds+US$1.4 billionA third consecutive month of increased holdings, below the second-quarter monthly average of +US$3.0 billion
• CIBM account purchasing strengthHighest since 2025This channel is more representative of medium- and long-term institutional investors
• Southbound Bond Connect quotaIncreased from RMB500 billion to RMB800 billionThe formal quota increase following further regulatory easing
• 2026 Southbound Bond Connect flowsAlready exceeded the full-year 2025 totalCumulative flows as of the report period
• Share of dim sum bonds issued by non-Chinese issuers24%Share of issuance so far in 2026, up from 19% in 2016
• USD/CNH spotAround 6.72Entered a lower trading range this week
• Potential RMB fixing levelBelow 6.78The report believes the central bank's fixing bias against RMB appreciation has eased at the margin
• Year-end USD/CNY forecast6.70A weaker dollar creates downside risk to this forecast
• Change in the RMB REERDown around 15%–20% from the 2022 peakThe real effective exchange rate adjusted by CPI and PPI
• Change in the RMB NEERAppreciated by more than 5% since 2022A clear divergence from the decline in the REER

Impact & implications

The report believes weak growth and fiscal transmission do not necessarily mean that all Chinese assets will come under pressure simultaneously. Neutral positioning reduces the impact of data surprises, soft growth supports lower rates, and the curve structure makes ultra-long government bonds relatively more attractive than intermediate tenors. Offshore bond inflows, southbound demand, and low-cost RMB financing continue to expand the RMB bond market. If corporate FX conversion recovers, the central bank reduces its resistance to appreciation, and the US dollar weakens, the RMB could enter a self-reinforcing appreciation process. Meanwhile, the decline in the REER should be understood more in the context of low inflation and differences in global macroeconomic cycles rather than being viewed directly as deliberate nominal exchange-rate undervaluation.

Risks

• Changes in local government leadership could prevent the remaining government bond quota from translating into sufficiently strong fiscal stimulus.
• Seasonal financing pressures in the coming weeks could tighten liquidity and constrain a broad near-term rally in government bonds.
• The scope for substantial policy rate cuts is considered limited, while the shortest-end rates already carry a negative-carry cost.
• US dollar weakness, changes in the central bank's fixing bias, and a recovery in corporate FX conversion create downside risk to the year-end USD/CNY forecast of 6.70.

What to watch

• Monitor whether government, local government, and policy bank bond issuance accelerates in the coming months and is effectively transmitted to infrastructure and manufacturing investment.
• Monitor seasonal funding pressures, the frequency of central bank overnight reverse repos, and supplementary liquidity injections.
• Monitor whether the 10-year–30-year government bond spread can continue to narrow from around 14bp above the model-implied fair value.
• Monitor offshore purchases through CIBM accounts, Southbound Bond Connect quota utilization, and the expansion of dim sum bond issuance.
• Monitor whether the corporate FX settlement ratio, RMB total returns, and corporate dollar selling recover together.
• Monitor whether the central bank's fixing bias continues to weaken and whether the fixing can fall below 6.78.
• Monitor whether the gap between the RMB REER and NEER ultimately converges through changes in inflation or gradual nominal appreciation.