Treasury Market Sees Bond Surge, Yields Climb

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Following the Spring Festival holiday, the financial landscape has been characterized by a pervasive tightness, resulting in adjustments within the short end of the bond market while long-term bonds have showcased resilienceThe recent surge in yields on newly issued government bonds has provoked renewed scrutiny on the banking sector’s liquidity issues, prompting market participants to raise questions regarding the availability of funds.

Experts interviewed for their insights have suggested that given the internal and external economic environment, the pace of monetary policy easing may slow downCoupled with aggressive credit disbursement by banks and an increasing supply of local government bonds, the short-term funding scenario is likely to remain in a state of tight equilibriumNevertheless, there remains a cautious optimism towards a long-term monetary easing, with close attention being paid to the timing of potential reserve requirement ratio (RRR) cutsHowever, institutions are becoming increasingly vigilant regarding the risks associated with possible pullbacks in long-term bonds, as the central bank continues to prioritize the prevention of long-bond yield volatility.

Last Friday, both the one-year and fifty-year government bonds witnessed significant spikes in their issuance rates, driving government bond yields up across the boardSpecifically, yields on one-year, five-year, ten-year, and thirty-year government bonds rose by 11 basis points, 4 basis points, 2.1 basis points, and 2.5 basis points, respectively, highlighting the upward trajectory.

On February 17th, the central bank engaged in a considerable 1.905 trillion yuan reverse repurchase operation with a term of seven days, reaching a repurchase rate of 1.5%. Notably, a total of 2.29 trillion yuan in reverse repos was set to mature on that very day, indicating a continued engagement in liquidity management.

The surge in government bond yields was particularly notable on February 14th, when the Ministry of Finance issued three batches of bonds, encompassing one-year, ten-year, and fifty-year maturities, amounting to a total of 243 billion yuan.

To break this down, the one-year bond had an issuance size of 107 billion yuan with a yield of 1.2866%, while the ten-year bond totaled 116 billion yuan, yielding 1.6100%. The fifty-year bond, on the other hand, had a smaller size of 20 billion yuan and yielded 1.9070%. These bonds exhibited bidding ratios of 2.23 times, 2.76 times, and 3.65 times, respectively.

When comparing the issuance yields with the second-hand market dynamics, both the one-year and fifty-year bonds were issued at rates exceeding their respective secondary market prices on that date

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For instance, the opening yield of the one-year bond on the secondary market was 1.3%, closely aligning with the estimated issuance rate of 1.3%. In contrast, the fifty-year bond had an opening yield of 1.89%, slightly outperforming its anticipated issuer rate of 1.9%.

The result of these heightened yields caused immediate rebounds in both bond categories, contributing to widespread concerns about liquidity, particularly following a robust financial performance in January, which exacerbated fears in the marketBy market close, the yields of one-year, five-year, ten-year, and thirty-year bonds had all climbed to notable highsThe fifty-year bond concluded the session at 1.91%, witnessing a notable three-basis-point increase throughout the day.

Investment institutions perceive the current aversion to government bond issuance as being driven predominantly by concerns about the negative interest rate environment for loansThis situation is compounded by the persistent aversion to risk stemming from tight funding conditions, suggesting that banks are struggling with liquidity, further underscored by the anticipated arrival of capital that had not materialized post-festivities.

Despite expectations for increased liquidity after the holiday, the absence of liquidity has since caused a significant tightening of the overnight repurchase rate (DR001) and the seven-day repurchase rate (DR007), whereby the observed yield inversion has persisted since February 7th.

Moreover, data reveals that in the two weeks following the Spring Festival, the central bank conducted net liquidity withdrawal operations amounting to 10.213 trillion yuan and 4.709 trillion yuan through the open marketA chief economist at Citic Securities intimated that although the post-holiday financial climate feels constricted, banks currently grappling with liability pressures are still experiencing a net withdrawal in liquidity operations, reinforcing a contrasting stance between loose monetary policy rhetoric and adept operational strategies.

Simultaneously, the persistent downtrend in government bond yields has intensified the “negative carry” condition between borrowed funds and investment returns, thereby motivating institutions to liquidate their short-term bonds more aggressively.

According to Qinhong, a fixed-income analyst at Zheshang Securities, the ongoing buying spree from major banks and rural commercial banks has resulted in a persistent carry-over of negative interest, instituting upward pressure on short-bond yields due to continued tight funding

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Nonetheless, certain investors, including insurance companies and funds, display a preference for longer-dated bonds, which has subsequently fostered a stronger state in the ultra-long bonds, engendering a bearish steepening of the yield curve.

Analyst Lv Pin of Debang Securities underscores that the current tight liquidity combined with softening short-bond yields cannot solely be attributed to central bank guidanceShifts in the deposit landscape between large and small banks since last year have led to a scenario where large banks have lost deposits to smaller competitors, creating a structural mismatch that further complicates the liquidity situation.

February 14th also showcased multiple interest rate increases, with the average weighted rate for DR001 climbing by 5 basis points to 1.9135% while DR007 experienced a 12.13 basis point increase to 1.9412%. Rates at both the Shanghai Stock Exchange and Shenzhen Stock Exchange reflected similar upward trends, demonstrating a broader market implication.

The outlook for funding conditions remains decidedly cautiousObserving the post-holiday developments within the bond market, overall yields have experienced a consistent downtrend that has characterized the last quarter, briefly pushing the ten-year government bond yields below 1.6%. This environment has raised questions regarding the sustainability of long-term bond strength.

Analysts express skepticism about the enduring strength of long-term bonds, suggesting they may soon align more closely with the changing expectations of the marketConversely, short-term bonds are anticipated to encounter less volatility, signaling a potential shift toward a bearish steepening of the yield curve and recommending a defensive posture against loan duration risks.

Despite prevailing expectations of monetary easing, analysts are suggesting that the rhythm of such policies could shiftThe mid-term adjustments in bond markets might continue unabated, and the dynamics of long- and ultra-long bonds might face challenges, consolidating financial market positions and possibly initiating downward trends

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Pinch suggests that a threshold of around 1.9% could delineate the upper boundaries for the ten-year government bond yields for the next one to two quarters as market resilience juxtaposes with a fluctuating risk appetite.

From a fundamental perspective, the January financial data has exhibited promising signs, but seasoned analysts maintain that the impact on liquidity perceptions may overshadow improvements in demandThe pronounced uncertainties at the commercial banking sector level could become a prevailing source of concern going forward.

As more government bonds flood the market, the possibility of ameliorated funding conditions lies heavily on the central bank’s forthcoming maneuversAs noted, without significant shifts in fundamental economic measures or consequent policies, these aspects will critically influence the future trajectory of the bond market.

Qinhong has indicated that the upcoming week will be rife with potential funding disruptions, characterized by maturing medium-term lending facility (MLF) obligations, a rise in tax payments, and the scheduled government bond repaymentsNevertheless, a tempered stance is advised as expectations for relative stability in liquidity levels persist, placing current conditions in a tight equilibrium rather than extreme constriction akin to past liquidity strains observed during previous years.

Lastly, regarding monetary policy, analysts suggest that the three components of the central bank’s decision-making paradigm do not presently substantiate further easing measuresRecent communications have also indicated a more prudent stance is anticipated at upcoming meetings, openly aligning with external economic situations and local market variationsThe upcoming tax deadlines paired with the resolutions on MLF maturity and potential reverse repo activity could blend to alleviate short-term pressures, although the path forward foreshadows a balance of vigilance within prevailing fiscal frameworks.

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