By Reshma Kapadia

Financial markets in China have started 2025 on the wrong foot, underscoring the flagging confidence that Beijing will take strong enough measures to revitalize its struggling economy.

This week, Chinese 10-year government bond yields hit a new low, suggesting investor pessimism about the country's long-term economic health, and the yuan weakened past a key technical level against the dollar. Stocks kicked off the year in the red, with the China CSI 300 index down 4% so far in 2025.

All these moves point to investors' fears that China's sluggish economy could become more like Japan's, which is known for several decades of low growth, low inflation, and low interest rates following a real estate collapse.

China's economy has been struggling with its own property slump. That has dealt a severe blow to consumer confidence, with households holding a majority of wealth in real estate and prices still falling. On top of that, tighter state control of the private sector -- including a harsh crackdown on internet companies -- has left businesses wary of hiring and investing.

The market "is telling us that the risk of Japanification is clearly rising, perhaps at an accelerating rate if policymakers don't act more forcefully," Todd McClone, a portfolio manager for William Blair's emerging markets strategies, told Barron's in an email. "The bond market is calling for policymakers to make the leap to the 'whatever it takes' moment regarding fiscal and monetary policy -- which so far they have unfortunately seemed unwilling to do."

Chinese officials vowed this fall to be more forceful in reviving the economy by tackling deflation and rebuilding dwindling consumer and private sector confidence this fall. Beijing has cut interest rates, eased monetary policy through other measures, and rolled out a spate of measures that have kept the economy from free-falling, but haven't revived growth sustainably.

As a result, investors are wary: There has been little follow through or details to show that Beijing is moving away from its incremental approach to stimulus and thinking outside of the box to jump-start the economy. The iShares MSCI China exchange-traded fund is down 16% in the past three months.

Another risk to the economy looms overhead: President-elect Donald Trump could follow through on his plans to increase tariffs on all Chinese imports.

Investors and strategists are waiting for more stimulus, including fiscal measures, aimed at repairing business and consumer confidence. Most, however, don't expect the details they crave until at least until the National People's Congress, possibly in March -- giving officials time to pivot based on what trade policy come out of the U.S.

The latest moves in the bond and currency market, though, could be Beijing's way to deal with some of the economic pressure. After weeks of holding the line on the yuan, Beijing allowed the managed currency to breach 7.3 to the dollar on Friday, while the yield on China's 10-year government bond hit a fresh low of 1.6%.

Michael Kelly, global head of multi-asset at PineBridge Investments, which oversees $203 billion, doesn't share the market's enthusiasm for Beijing to take on more fiscal spending given the high levels of debt they are already grappling with.

"If they can handle more of the adjustment through a lower global government bond yield and a yuan that is lower versus the dollar but maintains stability against Global South currencies, that is the right thing to do -- and stabilizing for world markets," says Kelly, who sees a gradual move in the yuan toward 7.50 per dollar as reasonable.

Weakening its currency is one of the tools analysts expect Beijing to use to mitigate the hit from potential U.S. tariff increases as it would help its exporters. But it's a delicate balance, with sharp currency moves raising the risk of capital outflows and financial instability. Economists are skeptical.

"The bond market is acting like it has realized there is no direction for the Chinese economy but down," says Derek Scissors, a senior fellow at the American Enterprise Institute. "The central government isn't willing to take the dramatic steps needed to juice the economy."

The question now is if China will take big enough steps to change investors' minds.

Write to Reshma Kapadia at reshma.kapadia@barrons.com

This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.

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January 03, 2025 16:12 ET (21:12 GMT)

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