(The opinions expressed here are those of the author, a

columnist for Reuters.)

By Jamie McGeever

ORLANDO, Florida, Jan 8 (Reuters) - China, the global

growth engine for the last 20 years, now boasts lower long-term

bond yields than Japan, the former poster child for deflationary

economic stagnation. This may signal that the "factory to the

world" faces the real risk of "Japanification."

China's bond yields have plunged to their lowest levels on

record, with the two-year yield about to break below 1.00%,

having been 1.50% only a few months ago. Remarkably, China's

30-year yield recently fell below the Japanese Government Bond

(JGB) yield for the first time ever.

That phenomenon looks set to hit the 10-year tenor, with

China's bond yield now less than 50 basis points above its JGB

equivalent.

It's a situation that would have scarcely been believable to

any observer of the global economy over the past 30 years. But

here we are.

The collapse in Chinese yields is a reminder that the

deflation, bad debt dynamics and troubling demographic trends

plaguing Asia's largest economy today are strikingly similar to

those that hobbled its fiercest regional rival for three

decades.

CAPITAL FLIGHT

Japan has recently begun to free itself from its decades of

deflation, sluggish growth and negative interest rates, enabling

the Bank of Japan to begin gradually "normalizing" rate policy.

Meanwhile, Beijing is struggling to reflate an economy

slammed by COVID-19 pandemic shutdowns and a property sector

bust. Deflation, lackluster consumer demand and capital flight

forced Beijing to announce unprecedented stimulus and liquidity

measures late last year.

Investors initially cheered Beijing's pledges, but the

optimism has faded quickly. Chinese stocks are down 5% so far

this year and are underperforming their regional and global

peers.

The country's foreign exchange reserves also tumbled $64

billion in December, representing nearly 2% of China's total

stash. This was the biggest monthly fall since April 2022 and

one of the steepest since the yuan slide and capital flight of

2015-2016. Analysts at JP Morgan reckon the sharp drop was a

result of Beijing's efforts to mitigate capital outflows in

December, which they believe neared $80 billion.

China's plight is exacerbated by the very real risk of

another U.S.-Sino trade war once President-elect Donald Trump

officially begins his second term in the White House later this

month.

And if UBS economists are right, China's economy will grow

just 4.0% in 2025 compared with 4.9% last year. Apart from the

pandemic-ravaged years of 2020 and 2021, that would be China's

lowest growth since it emerged as a global economic force in the

1990s.

Those with a decent memory will recall that it took decades

for Japanese property and equity prices to recover their

pre-crash peaks following the country's real estate bust in the

early 1990s. It's too early to know if a similar fate awaits

Chinese assets, but investors right now are unquestionably

pessimistic.

'TACTICALLY NEUTRALISING'

Consequently, many are reevaluating their relative exposure

to these two Asian powerhouses.

Societe Generale's asset allocation team said at the end of

last year that it was "tactically neutralising" the Chinese

equity allocation in its portfolio from overweight, as it

increased its exposure to Japan. This week, analysts at HSBC

slashed their year-end forecast for China's 10-year yield to

1.2% from 1.8%.

The generally pessimistic and optimistic consensus outlooks

for China and Japan, respectively, are obviously not without

risk.

Perhaps Japan won't "normalize" as quickly as many expect.

The country has not seen interest rates as high as 0.5% in

nearly 20 years, which helps explain Japanese policymakers'

caution. Indeed, economists at Barclays recently pushed out

their forecast for the next BOJ interest rate hike to March from

January and the timing of the subsequent increase to October

from July.

In the short term, the inverse correlation between Chinese

and Japanese bond yields may fizzle out or even reverse, simply

because it has been too powerful in recent months to be

sustainable.

But longer term? Beijing has its work cut out.

(The opinions expressed here are those of the author, a

columnist for Reuters.)