The bond market has recently shown signs of turbulence since late April, and this trend has continued into MayThis volatility has led to growing concerns among investors, especially given the strong performance of the bond market in recent yearsMany are now questioning the reasons behind this fluctuation and whether the bond market remains a viable investment option.
Firstly, it is important to understand the underlying factors contributing to the recent fluctuations in the bond marketSince August of last year, various sectors within the bond market have experienced a surge in prices, notably weaker-rated urban investment bonds across different durationsThis surge resulted in credit spreads and term spreads reaching historically low levels.
Specifically, long-term and ultra-long-term bonds have seen yields fall to unprecedented lowsData from Wind indicates that the yields on 10-year and 30-year government bonds hit record lows on March 6, with respective figures of 2.27% and 2.43%. This rapid decline in long-term rates has flattened the yield curve, with the 30-year minus 10-year spread compressing to a mere 12 basis points.
Central intervention also played a significant role, particularly due to a policy implemented in the fourth quarter of the previous year aimed at stabilizing urban investment bondsThis policy strengthened the expectations of bond repayment over the next two years and alleviated credit risks, resulting in a sharp decline in credit spreadsAs a result, short-duration, low-rated urban investment bonds appeared to have solid fundamental support.
However, starting from November, the weakening of credit spreads in these bonds, along with the rise in interest rates, indicated an absence of sufficient fundamental support for the long-duration and perpetually low-rated bonds, leading to an uneasy market sentiment.
Market sentiment has turned quite diverse lately, with a noticeable shift reflected in investor psychology
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Observations suggest a few prevalent mentalities among investors:
Firstly, there is anxiety that the bond market has surged too muchWith interest rates nearing historical lows, many investors are adopting a profit-taking mentality, worried that the market's momentum might not be sustainable and could lead to further declines.
Secondly, fears regarding the increased supply of government bonds have prompted cautionOn May 20, the first tranche of ultra-long special government bonds was opened for individual investors, and the enthusiastic response led to its early subscription limit being reached within minutesThis was shortly followed by a second tranche that saw similar rapid uptakeGiven that these government bonds are generally seen as low-risk assets, any increase in their supply could exert pressure on bond prices.
Moreover, with a total issuance target of 3.9 trillion yuan for the year and a slow start in the previous four months, a consistent increase in the issuance of special bonds is anticipated, leading to potential supply pressure that might disrupt investor strategies and market performance.
Thirdly, uncertainties surrounding potential monetary policy actions by the central bank are also at playApproaching the end of the month, signs of convergence in funding rates have emerged, and with the central bank's cautious stance towards long-term bonds, expectations for monetary easing remain subduedThe likelihood of a rate cut in June does not appear strong, which could lead to disturbances in the bond market.
Additionally, the pace of recovery in the real economy remains uncertain, especially as stringent real estate policies are being implementedAn unexpectedly rapid recovery could bolster corporate and consumer confidence, consequently leading to increased demand for liquidity and upward pressure on market rates.
Given this backdrop of uncertainty and fluctuations, the question arises: what changed that led to the recent developments in the bond market?
Three main reasons underpinning the bond market's strength since the beginning of the year—asset shortages, low-risk appetite, and expectations of loose monetary policy—haven't seen significant change
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Thus, analyzing these can help us understand whether the foundation of the bond market’s strength has shifted.
Firstly, there is a notable asset shortageThe recent resilience of the bond market can be traced back to a decrease in high-yield assets, which forces risk-seeking capital into lower-risk zonesThe decline in high-yield assets following the package debt restructuring has made scarcity a pressing issueConsequently, investors with higher risk appetites find themselves compelled to explore lower-risk options for generating returns, contributing to a repricing of risk-return dynamics in the bond market.
This “asset scarcity” phenomenon has been a significant driver in the bond market's remarkable performance, resulting in compressing various spreadsAs these spreads narrow, a “profit-making effect” emerges, attracting further institutional investment and enhancing the bond market's appeal.
As to whether the asset shortage issue has improved, one can argue that the macroeconomic backdrop suggests it will remain a challengeThe current economic cycle indicates early recovery, with liquidity being adequate but the real financing demand remaining weakRigid capital costs continue to chase the diminishing premium assetsFurthermore, in this period of structural transition, traditional high-yield instruments are phasing out, while new opportunities in high-yield assets have yet to materialize, maintaining expectations for asset shortages over the short-to-medium term.
Next, there’s the prevailing low-risk appetiteDespite stable economic performance and signs of recovery, market volatility coupled with external disruptions continues to weigh heavily on investor sentimentAs a protective measure, capital flows predominantly favor fixed income, which reinforces the bond market's strength.
Long-term, the interplay between the internal and external environments leads to more cautious expectations among market players
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The current transitional period in the economy starkly contrasts with the robust cycles of the past few decades, where investor confidence was buoyed by expansive consumption and effective demand.
With demographic shifts and structural wealth distribution contributing to a natural decline in risk appetite, alongside global uncertainties, the complexity and longevity of these shifts offer little room for quick reversals based on short-term fluctuations.
Lastly, the expectations for continued loose monetary policy remain intactObservations reveal that even with a stable monetary stance, the prevailing sentiment anticipates further easing, as reflected in the market's monetary policy expectation index, which has mostly remained low—indicative of ongoing expectations for liquidity support.
Consequently, potential shifts in global interest rates, especially if central banks in Europe and the U.S. proceed with cuts, could mitigate pressures on the Chinese RMB, hence enabling the central bank to maintain ample market liquidity.
In summary, despite the current minor fluctuations in the bond market, the principal factors driving its robust performance—asset shortages, low-risk appetite, and expectations for loose monetary policy—remain intactConsequently, the bond market will continue to gauge reactions to the evolving landscape of government bond supplies and real estate implications without any dramatic shifts currently in sight.
For ordinary investors navigating this complex bond market environment, several strategies come into playFocusing on underlying economic growth, recognizing that the impact of policy changes evolves gradually, is paramountInvestors should closely monitor policy shifts, the effects of expanded credit, and the central bank’s monetary stance, adjusting strategies accordingly.
Moreover, adopting a long-term perspective can illuminate various trends obscured by short-term volatility
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