A China Construction Bank worker counting renminbi banknotes in Hai'an, Jiangsu province. Falling bond yields have made investors turn to other avenues like commodities and equities. [CFP]

Adding more credibility to the view has been the nearly 70-percent rise in the A-share market since the beginning of the year and the anticipation of an ensuing inflation activated commodities trading.

On the supply side, China plans to issue around 1.7 trillion yuan ($248.88 billion) treasury bonds for the whole year. Bonds worth 652 billion yuan have been issued in the first half, leaving some 1.1 trillion yuan worth of bonds to be sold in the second half.

"The supply is huge, but demand is obviously very sluggish," Xu Jin, analyst, Shanghai Securities said.

Recently, the Ministry of Finance failed to find buyers for debt worth $1.7 billion as not too many investors showed interest in the auctions.

"With bank interest rates likely to go up in the near future, the allure for treasury bonds may fade," Zhu said.

Investors are growing wary of Chinese debt as the nation's economy is growing faster than expectations. China's gross domestic product grew 7.9 percent in the second quarter, beating the median estimate of 7.8 percent in a Bloomberg survey of eight economists.

Chinese policymakers need to "fine-tune" the policy to prevent asset bubbles, loan defaults and faster inflation, Zhang Jianhua, head of the central bank's research bureau, wrote in China Finance magazine this month.

Wu Xiaoling, former central bank deputy governor, said at a forum recently that the central bank might have to raise banks' reserve requirements to mop up excess liquidity.

"Under conditions of overcapacity, excessive bank lending in China is flowing into the stock and property markets and could inflate asset bubbles," Wu said.

The nation's inflation rate may accelerate to 5 percent in 2010, topping the 1.3 percent outlook for the US, according to China International Capital Corp, a Beijing-based investment bank. Chinese consumer prices fell 1.7 percent in June from a year earlier.

"The interest rate hike could happen at the end of 2009 or the beginning of 2010," said Li Mingzhong, a bond market analyst with Guoyuan Securities.

"(The interest rate hike) could happen within the year. But overall, it depends on the economic situation in the third quarter," Zhu from Guangfa Fund Management Co said.

"Bond yields at the current levels are not that attractive. Unless the yield increases, investors won't be interested in it," Zhu said.

China's five-year yields rose on July 21 for the 16th consecutive day, the longest stretch since at least 2006, to 3 percent.

Five-year yields in China will probably climb to 4 percent this year, said Tim Condon, the Singapore-based head of Asia research at ING Group NV, the largest Dutch financial services company. Investors would lose 2.8 percent if his prediction is proven to be correct, according to Bloomberg.