China’s government bond market has rallied this year even though the central bank has not cut its key policy rate once, with the entire move in the long end driven by investor expectations of a future cut that may — or may not — materialize on the timeline the market currently prices. In a new report, CICC cautions that the gap between what the market expects and what policymakers are willing to deliver is the defining tension in Chinese rates right now.

The mechanics are striking. The People’s Bank of China last adjusted its 7-day reverse repo rate — the de facto policy rate — by 10 basis points in 2025, bringing it to 1.40%, but has left it untouched since . And yet the yield on the 10-year government bond has fallen 15 bps this year to 1.69% as of August 28, having broken below 1.8% in early April and below 1.7% in mid-August . By contrast, in 2025 the same policy rate was cut by 10 bps but the 10-year yield actually rose 17 bps across the year .

The inversion of that historical relationship is the heart of CICC’s analysis. “This year the government bond market has shifted from last year’s corrective phase to a ‘yield-curve decline without rate cuts,’” the research team writes, noting that the current episode — 477 days and counting since the last policy-rate adjustment — is already the longest such stretch without a cut since the 657-day span between March 2020 and January 2022 .

The Short End Hasn’t Budged — Only Expectations Have

Critically, the downward move in long-bond yields is not being driven by looser funding conditions. CICC’s data shows that DR001, the overnight interbank repo rate, averaged 1.40% on a 7-day moving basis as of August 28 — actually higher than the 1.32% level seen at the end of March and early April . The central bank’s own reforms tell the same story: in a much-anticipated move at the Lujiazui Forum in June, Governor Pan Gongsheng narrowed the short-end rate corridor from 70 to 50 basis points and introduced an overnight reverse repo tool whose rate sits distinctly below the 7-day rate . Yet the net effect has not been to pull short-term money-market rates lower .

That leaves only one explanation: the 10-year yield’s descent is a pure play on rate-cut expectations. Using FR007 interest-rate swaps — the standard market gauge for forward policy-rate pricing — CICC finds that as of August 28, the market-implied probability of a rate cut over the next 12 months had risen to a level stronger than that seen in early September 2024 and August 2023 . Its term-premium model shows expected short rates drifting 5 bps lower versus end-March and 10 bps lower versus year-end 2025 .

The Fundamental Tension: Markets vs. Policymakers

CICC’s core thesis is that the same underlying driver — relatively weak domestic demand — produces opposite conclusions for the market and for the central bank.

The market’s logic: Total social financing (TSF) growth has cumulatively declined 0.9 percentage points this year, versus a 0.3-point increase over the whole of 2025 . The deceleration in TSF, which began in August 2025, lines up almost perfectly with the rise in rate-cut probabilities since September 2025 . With financing demand soft, sluggish fiscal bond issuance so far in 2026, and a market consensus that fiscal discipline will tighten structurally over the long run, the rate-cut bet keeps building.

The policymaker’s logic: The PBOC is weighing the costs of cutting, not just the benefits. Every time the policy rate has been lowered, lending rates have fallen by more than deposit rates, eroding banks’ net interest margins . At the same time, lower rates have produced diminishing incremental credit demand; with margins compressed, banks have become more cautious underwriters, tightening lending standards even as the PBOC tries to stimulate. The financial regulator’s data shows that while non-performing loan ratios across bank categories have stayed broadly stable since 2025, net issuance of NPL-backed asset-backed securities has risen — evidence that banks are offloading credit risk through market-based channels .

“Rate-cut expectations are a necessary but not sufficient condition for an actual cut,” CICC concludes, arguing that the timing of any real policy move remains uncertain and will likely require additional confirmation from the real economy .

If a Cut Comes, Banks Need a Capital Cushion

The report lays out two distinct pathways for a rate cut, each with different implications:

• Rate cuts via market rates running persistently below the policy rate — opens room for long-end yields to fall, but leaves existing loan pricing untouched. Bank net interest margins still face narrowing pressure, but the stock of loans is unaffected.
• Rate cuts via an explicit policy-rate reduction — opens far more room for long-end yields to fall, with LPR highly likely to follow, repricing outstanding loans and hitting bank margins much harder. There is also a theoretical possibility of tiered adjustments, where the reverse repo rate and LPR are not moved by equal magnitudes.

In either scenario, CICC argues, regulators will need to arrange financial institutions’ net capital more carefully before financing demand recovers. Potential tools include adjusting dividend payout policies, supplementing net capital, and optimizing relevant regulatory metrics .

The Broader Market Backdrop

The report arrives amid a week of mixed signals. China’s industrial profits for the first seven months of 2026 grew 17.6% year-on-year, with July’s growth at 11.2% — a 3.9-point deceleration from June as both revenue and costs squeezed margins . Property remains under pressure: sample-city new-home transaction volumes were down 14.3% year-on-year, with 30-city new-home sales flipping from +0.4% to -11.3% in the last week of August . Government bond net issuance for January–August ran 1.5 trillion yuan below the same period last year .

Meanwhile, the U.S. side is pulling in the opposite direction. In a Jackson Hole address, Federal Reserve Chair Kevin Warsh called the 2% PCE inflation target “a firm, fixed target” and signaled that if underlying inflation does not return to 2% fast enough, the Fed will act — pushing short-end U.S. Treasury yields higher and flattening the curve . CICC notes, however, that America’s ability to sustain high long-end rates is constrained by fiscal reality: with government debt-to-GDP already beyond the 90th percentile of the historical rate-debt relationship, the analysts argue that “financial repression” — with the Fed expanding its balance sheet to ease liquidity pressure — may ultimately prove necessary .

For China’s bond market, the practical implication is that the 10-year yield’s next 10–15 bps of movement hinges less on domestic fundamentals, which are already well understood, and more on when — and whether — the PBOC decides that the benefits of a rate cut finally outweigh the costs to bank balance sheets. Until then, the market is left holding a very expensive bet on a cut that grows more probable with every passing week of weak financing demand, yet remains at the mercy of a central bank that has shown it can hold the line far longer than traders expect.