We expect a bear steepening bias along the CGB curve, driven by a gradual repricing of inflation and policy expectations. While domestic demand remains uneven, resilient exports and industrial activity have reduced the urgency for aggressive easing. At the same time, higher-for-longer oil prices are reshaping inflation expectations.
First, the pass-through from oil to upstream prices remains significant. Historically, the correlation between PPI and Brent crude stands at 0.84, suggesting that higher oil prices could continue to normalize PPI toward positive territory. Recent geopolitical developments have also tightened supply conditions, with disruptions to Iranian exports removing an estimated 1.0–1.4mb/d of supply to China, forcing refiners to source higher-cost alternatives. While China maintains substantial reserves—covering around 118 days of imports—replacement costs are rising in a tighter global market.
While the transmission to CPI is more contained – given the pricing band mechanism and still-soft domestic demand – we estimate that headline CPI could rise by around 1.1ppts to approximately 1.6% yoy if Brent sustains in the USD100–150/bbl range for two quarters, before moderating. This would mark a shift from the current benign inflation backdrop, supporting higher real yields and limiting front-end easing pressure.
Second, monetary policy is likely to turn more measured. With the Fed constrained in its easing cycle and the USD remaining firm, the PBOC faces a narrower policy corridor, balancing domestic growth support with FX stability. A stronger USD environment also reduces the need for aggressive rate cuts to offset capital flow volatility. In addition, rising imported energy costs could further complicate easing, as policymakers weigh growth support against imported inflation risks. Under this scenario, we expect the PBOC to adopt a more cautious easing approach, with only a 10bp cut to the 1Y LPR delivered if Brent sustains in the USD100–150/bbl range for two quarters, while relying more on targeted liquidity tools and balance sheet measures.
Taken together, downside on the front end is fading, while long-end yields may drift higher on rebalancing inflation expectations.
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