China’s ultra-long government bonds are seeing heated demand as the economy’s dire outlook and expectations for modest stimulus drive bets for further gains.

The yields on China’s 15- and 20-year government bonds tumbled to the lowest since 2002 this week, while those for 30-year notes are hovering near levels unseen since 2005. Transaction volume for longer-dated securities has surged to a multi-year high.

The moves gathered pace as China’s slower-than-expected economic growth triggered a rush of forecast downgrades at Wall Street banks including JPMorgan Chase & Co. and Morgan Stanley. Repeated vows by Beijing to support businesses and consumption have failed to rekindle risk sentiment, while stimulus expectations remain low ahead of the Politburo meeting.

Expectations that authorities may tolerate modest growth to focus more on quality, along with low inflation, have driven the rally, said Wang Hua, head of fixed income at Pengyang Asset Management in Beijing, which manages over 130 billion yuan ($18 billion). Volatility can increase ahead of the Politburo, but yields may head even lower if policy announcements disappoint, he added.

The People’s Bank of China’s dovish stance has been a boon for overall Chinese bonds, but the gains have been larger for longer-dated securities as they are more sensitive to the inflation outlook. China’s deepening disinflationary trend — with flat consumer price gains and steeper losses in producer prices for June — bode well for the asset class.

Transaction activity in longer-dated bonds has jumped to the highest in at least three years, according to Bloomberg-compiled data from China’s National Interbank Funding Center. Turnover of cash bond trading on notes maturing in more than 15 years totaled 1.9 trillion yuan in June, the highest since July 2020 and more than double the monthly average in 2022.

The yields on China’s 20- and 30-year government debt have tumbled about 30 basis points since a March high to 2.85% and 3.00% as of the latest close, respectively. The premium that 30-year bonds demand over 10-year notes has averaged 38 basis points this year, versus a five-year average of 56 basis points through 2022.

All eyes are now on the upcoming Politburo meeting, which sets the tone for economic policy direction in the second half. While some say the rally can face a reversal should authorities decide to ramp up stimulus, bond bulls remain optimistic that the PBOC’s dovish stance and widespread pessimism over the economic outlook will keep such risks contained.

Subdued market reactions to a series of statements this week to boost the private sector and consumption shows there’s reason to believe the bond market has further to run. A benchmark gauge of Chinese stocks on the mainland ended in the red this week, while yields have continued to slip.

The bid-to-cover ratio at a Friday’s auction of 30-year sovereign bonds at 5.15 was the highest since October 2022, reflecting robust demand in the primary market. Foreign holdings of China bonds rose for a second month in June.

For some investors, however, the rally is ripe for a breather.

“Overall we had been overweight China government bonds for some time but gradually we’re taking profits,” Jason Pang, a portfolio manager at JPMorgan Asset Management, said in an interview with Bloomberg television. But “as you stack further policy relaxations, you can still get the firepower ammunition equivalent of something close to a bazooka stimulus,” he said.

‘Go Long Duration’

But the asset class has other reasons beyond low inflation and weak growth in their favor.

The introduction of 30-year bond futures has helped money managers to more frequently trade the notes and take longer duration, according to Chen Kang, chief fixed-income analyst at Northeast Securities Co. in Shanghai. Improved liquidity and hedging strategies add to the attractiveness of the market, he added.

Financial institutions — which typically absorb most of the long bond supplies — are also facing lower liability costs, giving them more room to buy the debt even at lower yields. Insurance companies have received regulatory guidance to stop offering products that guarantee returns higher than 3%, according to a local media report Thursday. China’s biggest banks have also been cutting deposit rates.

In its mid-year outlook last week, GF Securities Co. recommended investors to go long duration in the second half. “China’s interest rates will remain in a broad downward trend” as lower funding costs will be a key tool to balance fiscal revenue and spending in efforts to ease regional governments’ debt burden, wrote Liu Yu, chief fixed-income analyst at the brokerage.

--With assistance from Tania Chen.

(Adds 30-year bond auction result and foreign bond holdings data)