context: 2024 expansionary fiscal and monetary policies such as special refinancing bond issues, policy rate cuts and consumer subsidies aim to stimulate growth and tackle deflationary pressures. The Central Economic Work Conference called for ‘moderately loose monetary policy’ and ‘more proactive fiscal policy’ indicating that the current macroeconomic direction will continue into 2025. Market players seek to better position themselves for the future based on current expectations. This includes major banks, who have seen compressed margins in light of the real estate slowdown and falling interest rates.
PBoC (People's Bank of China) conducted a regulatory discussion with financial institutions that engaged in speculative trading in recent bond market movements on 18 December, reports Yicai. The meeting mentioned that financial institutions should
- carefully monitor and assess their risk status
- i.e. interest risk
- improve investment and research capabilities
- enhance stability of bond investments
PBoC has recently investigated and prosecuted financial institutions
- suspected of account lending
- distorting market prices
- engaging in collusion
- lacking internal management mechanisms
The central bank has stressed
- comprehensive investigation into non-compliant activity is underway
- routine compliance inspections to continue
- zero tolerance for illegal and non-compliant bond market activities
Futures prices for government bonds dropped following the meeting
- 30 year government bond futures dropped by 1.7 percent
- most actively traded 30 year futures contract dropped by 0.44 percent
- most actively traded ten year futures contract dropped by 0.1 percent
- most actively traded five year futures contract dropped by 0.2 percent
The recent bond market is starting to exhibit increasing volatility
- ten year government bond rates dropped from 2 percent to 1.8 percent
- 30 year yields fell to just under 2 percent
It is crucial to cautiously monitor and evaluate movements in the bond market to avoid risk accumulation, especially duration mismatch and interest rate risk for medium to long term bonds, notes Wang Xin 王信 PBoC Research Bureau director.
The recent bond yield declines have occurred too quickly because a handful of banks are aggressively trading in the interest bond market for short term profits, explains Zhang Xu 张旭 Everbright Securities head of fixed income. This could decrease banks’ willingness to issue loans to support the real economy.
Expansionary fiscal policy often negatively affects bond markets through
- confounding bond market supply and demand dynamics
- influencing investors expectations
Zhang adds that significant policy rate cuts are expected in the coming year. However, if expected cuts are not realised in the near future and economic indicators improve, market repricing of bonds remains uncertain. Hence, monitoring and managing duration risk is key.
The short-term is still defined by majority bullish sentiment, explains Jin Yi 靳毅 Sealand Securities head of fixed income. There is limited room for further bond price increases. Yield rates may continue to fall, then eventually stabilise.
Jin discusses recent bond market movements
- banks are now the primary buyers of ten year bonds
- funds used to be the dominant buyer
- funds and insurers are the primary buyers of 30 year bonds
- funds are rushing to buy ten year and 30 year bonds, with
- allocations focused on interest bearing bonds
- net purchases of ten year and 30 year bonds exceeding historical patterns
- longer holding periods
- insurers are increasing ultra long government bond holdings this week
- alongside active allocation in local government bonds
- major banks have collectively increased holdings in 5–7 to 7–10 year interest bearing bonds
- with longer holding periods
These movements are to
- make up for August bond sales
- prepare for potential bond purchase restrictions in 2025
Huatai Securities reveals that bond yields are reaching historic lows in light of
- year-end rush buying
- rate cut expectations
Historically, bond yields decrease by ten basis points following the December Central Economic Work Conference. A high probability of large short-term market volatility is prevalent as continuous yield drops trigger bond selling as trading parties close their take-profit positions to realise gains.
Bond price trends are driven by investors’ expectations on monetary policy and economic fundamentals, with monetary policy being the ultimate underlying determiner of bond prices.