The dynamics of the Chinese bond market have recently taken a stressful turn after a brief surge preceding the holiday seasonAs of May 6, a notable decline was observed, with the 30-year government bond ETF (Exchange-Traded Fund) dropping by 0.22%, settling at 111.295 yuanThis ETF, often regarded as a benchmark for long-term bonds, has been on a downward trend since it reached a peak of 115 yuan on April 23, showcasing a nearly 4% drop in two weeksThis situation has left many investors in long bonds feeling anxious as the stock market, in contrast, has shown vigorous growth, with the Shanghai Composite Index crossing the 3,100-point mark, and Hong Kong's Hang Seng Index rebounding nearly 24% since its lowest point.

The decline in long-term bonds can be traced back to a signal from the People's Bank of China (PBOC) regarding future economic policiesA combination of favorable real estate developments and a recovering stock market has exacerbated the "see-saw" effect between stocks and bonds

Prior to the May Day holiday, bond yields pushed higher but subsequently retracted, with the yield on a 10-year government bond rising to 2.35% before retreating to 2.30%. The yield on a one-year bond climbed to 1.69%, influenced by fluctuations in real estate expectations and decreased transaction capital, both contributing to adjustments in the bond market.

Despite these challenges, many industry experts believe the primary supporting factors for the bond market remain unchangedIssues concerning weak real estate financing and a shortage of high-yield credit bonds have not substantially altered, hence the prevailing risks in the bond market are considered manageableHowever, several short-term disturbances are emerging, such as adjustments to meeting policies concerning the property market and a potential mild recovery of nominal GDP growthCoupled with a rebound in the exchange rate and an uptick in the Hong Kong stock market, market appetite for risk appears to be warming up

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The possibility of accelerated issuance of special government bonds also looms ahead, yet the need to flexibly utilize monetary policy tools to bolster support for the real economy and reduce comprehensive financing costs is expected to confine the upward space for bond yields.

The "see-saw effect" between stocks and bonds has been particularly pronounced as the Shanghai Composite Index ramped up from a range near 2,600 points to 3,000 points during a time when the bond market was experiencing continuous gainsLong-term bonds, particularly the 30-year government bond ETFs, initially enjoyed a spike of as much as 15%, driven by several institutions that favored speculative investmentsHowever, the tide began to shift dramatically in April when volatility surged after the PBOC made unusual comments about long-term bond yieldsFollowing their announcement, the bond market experienced an abrupt setback, without the expected resilience.

By April 23, when the central bank's comments came to light, the bond bull market faced a significant reversal as prices corrected across the board

On April 26, a prominent 30-year bond saw its yield rise by 4.45 basis points to 2.5125%, surpassing the one-year Medium-term Lending Facility (MLF) interest rate of 2.5%. As of May 6, the yield for the same maturity bond settled at 2.54% as the evolution of market sentiments complicated the landscape for long-term bondsA bond trader from a brokerage firm noted that "in mid-April, it seemed that a yield of around 2.45% would allow for further accumulation, but the situation escalated significantly, forcing many institutions to cut back on their holdings."

The initial pressure on the bond market can be attributed to the PBOC's acknowledgment of longer-term yields which reflect economic growth and inflation expectations but also can be influenced by supply-demand dynamics and may result in "phase deviations." The PBOC has indicated it plans to ramp up the issuance of government bonds significantly this year, suggesting that the situation of "asset shortage" could ease and lead to a recovery in long-term bond yields.

The murmurings of regulatory warnings surrounding speculative behavior in long-term bonds have not helped market stability either

A trader from a city commercial bank remarked that there had been rumors in the market that financial guidance was advising caution about the risks associated with speculating on long bonds, particularly as smaller banks had been heavily investing in long-term bonds owing to fewer outlets for their fundsThe anticipated increase in issuance in May contrasted sharply with prevailing market sentiment, further complicated by speculation regarding real estate policies that sent shockwaves through the bond market.

In a recent meeting, there was a strong emphasis on ensuring the delivery of pre-sold properties without directly mentioning major initiatives concerning guaranteed housingSuch omissions have led markets to interpret the shift of focus as a critical step towards stabilizing real estate risksThe current wave of policy adjustments to relax buying restrictions, including a significant notification from Beijing to optimize housing restrictions, showcases a broader trend towards easing market conditions.

The anticipation of a tightening wave of policies is also underscored by recent events

Liu Yajun, research director at E-House, pointed out how the Beijing notification coincided strategically with the meeting, correlating with similar loosening in Chengdu and Tianjin"Starting in May, a series of concentrated policy relaxations will emerge, with modifications to restrictions becoming highlightsInitiatives based on a one-city-one-policy approach will significantly boost market activity throughout May and enhance overall market sentiments," asserted Liu.

The broader economic landscape reflects a promising start to the year for China’s macroeconomic performance, with GDP growth reported at 5.3% year-on-year, surpassing market expectationsImport-export figures alongside industrial production have been particularly encouraging, even as consumer spending remains lacklusterReal estate data, however, continues to show significant pressure as evidenced by a notable decline in both new construction and sales, further heightening scrutiny on the real estate signals emanating from recent meetings

In the first quarter, new real estate construction areas and sales both plummeted by 27.8% and 19.4%, respectively.

Despite the persistent downturn in bond prices, industry insiders largely agree that the moment for a comprehensive negative outlook on the bond market is not yet upon usWu Zhaoyin, a macro strategy director at China Aviation Trust, expressed that current bond yields across various categories and terms have fallen to historical lowsYields for 10-year government bonds and those for 5-year urban investment bonds rated AA+ are consistently marking new records"Unless there is an explicit adjustment in monetary policies, we believe it will be challenging for bond yields to continue declining dramatically but at the same time, significant increases remain unlikely," Wu stated.

This viewpoint stems from the understanding that current yields inherently reflect the machinations of monetary policy alongside economic fundamentals

The loosened monetary policy has generated ample liquidity in the market, despite the reduction in open market operations (OMO) to 2 billion yuanThe interbank lending market remains well-supplied, as indicative rates have not shown significant upward movementsWith premium assets generated by the real economy being relatively scarce and government bond issuance lagging, there are tensions in asset allocation versus supply, ultimately driving bond yields lower.

The prevailing consensus suggests that a wholesale bearish view on the bond market isn't yet warranted, as the economic climate is still under observationThe initial signs of economic recovery in the first quarter came with considerable challenges lying aheadOverall, effective demand in society is insufficient, leaving economic performance trailing below potential levels and escalating price pressuresThe Consumer Price Index (CPI) has repeatedly trailed normal values, with requirements set forth in meetings urging a vigorous approach to maintain the upward trajectory of economic recovery

Currently, no substantial indicators suggest further easing of monetary policy; however, there remains adequate policy space and a rich reserve of policy tools available, which may require a proactive decrease in policy interest rates to lower overall societal financing costs.

Fund evaluations from Bosera suggest that ongoing favorable policies towards property development are beneficial, with cities like Shenzhen and Nanjing launching programs aimed at transitioning old for newIn the face of a weak recovery in the housing market, optimism surrounding real estate policy continues to permeate the investor mindset, with future regulatory developments being highly plausibleAs industrial profit growth showed signs of deceleration in March, combined with somewhat stagnant consumption growth, the impetus for China’s economic expansion remains an urgent necessityAgainst this backdrop of a weak recovery, Bosera anticipates that monetary policy will sustain a tone of cautious loosening

After the recent adjustments, bond market risks appear to have diminished, but the stable improvement in China’s fundamentals has yet to firmly take shape, constraining the potential for significant rises in bond yields, with subsequent bond market performance likely tilting towards volatility.

Research head Wang Qiang from Nanyin Financial stated, "From the perspective of bond pricing, medium- to long-term yields have climbed approximately 10 basis points, while credit bonds and bank subordinated bonds have similarly faced increases of 15 to 20 basis points, reflecting a broader correction in overly optimistic market expectations." He predicts that bond pricing in May will also be affected by increasing supply and ongoing real estate policy shifts, indicating a forthcoming period of market consolidationOverall, there is an increasing assemblage of positions that could favor buying opportunities from a risk-return perspective, especially in focusing on 3- to 5-year interest-bearing government bonds and bank subordinated bonds."