As the financial landscape evolves, analysts are closely monitoring the bond market's trajectory, particularly as we approach the second quarter of the yearIt appears that we may still have some room for a decrease in bond yields during this periodHowever, as we transition into the third quarter, the accelerating momentum of economic recovery and unexpected increases in the Consumer Price Index (CPI) are anticipated to prompt a rebound in these yields.
Recent trends have shown significant fluctuations in 10-year government bond yieldsBetween March 10 and April 6, these yields oscillated within a narrow range of 2.85% to 2.87% over the course of 19 daysOn April 7, a notable decision led to a downward movement in yields, culminating on April 12 when they recorded a low of 2.82%. However, bolstered by substantially better-than-expected foreign trade data for March, market sentiments regarding economic growth shifted positivelyConsequently, enthusiasm for long positions in bonds diminished, resulting in a slight rebound in yields to 2.84% by April 17. Following this spike, economic data for the first quarter yielded mixed results, which resulted in another drop, taking the yields down to a remarkable low of 2.78% by April 28— the lowest since November 14, 2022. Notably, the 1-year government bond yield followed suit, also showing a decline of 8 basis points, landing at 2.15% by the end of April.
Several factors have contributed to this resilient performance in the bond marketFirstly, various medium and small-sized banks have revisited their deposit rates, prompting an upsurge in market expectations for interest rate cutsStarting from April 8, banks such as those in Henan Province adjusted their rates for 1-year, 2-year, and 3-year fixed deposits down to 1.90%, 2.40%, and 2.85% respectivelyThis adjustment was reflective of a pattern observed as many rural banks across China also revised their rates, which had previously been higher, signaling a shift in market dynamics
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This created an atmosphere conducive for speculating on potential reductions in the Loan Prime Rate (LPR) in April, further stimulating bullish sentiment in the market.
Secondly, March's CPI data registered significantly below expectations, reigniting discussions around deflationThe CPI noted an annual increase of merely 0.7%, falling below the critical 1% threshold and marking an 18 month lowThe Producer Price Index (PPI) similarly reflected a substantial decline, marking a worrying trend of weak demand, signaling a fragile economic recoveryExperts have voiced concerns that the Chinese economy may be on the cusp of deflation, inducing investors to believe that upward movements in short-term bond yields are unlikely.
Adding to the complexity of this scenario is the liquidity situation within the marketThe environment has been characterized by a relaxed funding situation, with institutions leveraging overnight debt acquisition to support the bullish tone in bond marketsNotably, the average Overnight Repurchase Rate (R007) dropped significantly by 21 basis points to 2.30% in April, indicating a robust availability of funds among non-banking institutions spurred by vigorous investment demandThere was a marked increase in the activity related to repo transactions, with daily volumes surpassing 7 trillion yuan during the early days of April and reaching a peak of 8.1 trillion yuan on April 6, thereby highlighting an increased eagerness among institutional players to capitalize on the performance of bonds.
The proactive stance taken by financial institutions has been pivotal in driving the market forwardData from the China Foreign Exchange Trading Center illustrates that during April, three main categories of bond purchasing actors—rural financial institutions, investment funds, and bank wealth management subsidiaries—played a crucial role in energizing the secondary bond market
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Specifically, rural financial institutions amassed large quantities of bonds, purchasing 214.9 billion yuan worth in the week of April 3, although subsequent weeks saw a reduction in this purchasing trend, ultimately shifting to net sales by the month’s end.
Investment funds and bank wealth management products served as the backbone of the rising bond market, frequently reporting net purchases exceeding 100 billion yuan on a weekly basisThe surging demand from fund companies correlates closely with the downward trajectory in bond yields witnessed during this timeframeInvestment institutions face stringent annual performance assessments, and having been out of the market during the early months of 2023, the pressure to not miss potential gains compelled them to be net buyers from February through April.
It's essential to view the factors driving the recent decline in interest rates within the broader context of prior adjustments in deposit rates by major banksThe reductions by smaller banks are largely seen as a step in line with these larger adjustments, rather than the initiation of a new cycle of declining ratesThe People's Bank of China has even made it clear that this is not an open door for a fresh round of rate reductions.
Looking closely at March's CPI drop reveals that it may have been influenced by last year's pandemic disruptions and surges in oil prices affecting the comparative base, in addition to seasonal fluctuations in food prices due to warming weatherAs we head into the second quarter, China's intrinsic economic drivers remain under repair, and we may see CPI levels oscillate at lower ranges before rebounding in the latter half of the year, thereby challenging the prevailing deflation narrative.
Essentially, the key elements propelling the bond market's bullish sentiment revolve around trading institutions driven by performance metrics
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