A Turbulent Phase in the Bond Market

Recently, the bond market has been experiencing significant fluctuations, stirring concerns among investors and financial institutions alikeFor instance, on August 12, the main contract for 30-year government bond futures plummeted below 110 yuan, reflecting a 1.24% dropSimilarly, the five-year and ten-year government bond futures contracts also faced declines of 0.34% and 0.62%, respectivelyThese downward trends have not just been confined to futures; the cash market for government bonds has followed suit, causing disquiet across various investment sectors.

The repercussions of falling bond prices have extended to bank wealth management products and pure bond mutual funds, which have witnessed noteworthy fluctuations in their unit net valuesInvestors have begun to question the stability of these financial instruments as they grapple with the realities of a shifting market landscape.

This phase of adjustment in the bond market can be traced back to the central bank's concerns regarding persistently low long-term government bond yieldsOver the course of 2023, the central bank has repeatedly issued warnings about the risks associated with long-term government bond rates, suggesting that their current levels are unsustainably low.

On July 1, in a surprising move, the central bank borrowed government bonds from state-owned banks in preparation for potential market interventionBy August 7, four rural commercial banks in Jiangsu were investigated for allegedly manipulating government bond pricesAs a result, the previously rising long-term government bonds encountered noticeable corrections, leaving many investors wary of the market's direction.

These recent developments raise an important question: Could we see a repeat of the drastic declines witnessed in late 2022? That period was characterized by a significant downturn in the bond market which deeply impacted both bank wealth management products and pure bond funds

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When bond prices dropped, the repercussions were immediate—investors were shocked as these products lost value, experiencing declines that meant a day's worth of gains could vanish in the blink of an eyeIn some instances, funds dropped below their face value, sparking concerns regarding the inherent risks associated with bond investments.

Following these extreme fluctuations, many investors redeemed their holdings in bank products and bond funds, forcing institutional investors to sell off their bond holdings, which in turn led to an even greater drop in bond pricesThis cycle of panic persisted until March 2023, when the volatility began to finally stabilizeThe turmoil ultimately resulted in a dramatic contraction of over two trillion yuan in the scale of bank wealth management products.

The current fluctuations have ignited fears of yet another catastrophic drop akin to what was experienced at the end of 2022. Analysts are divided on the probabilities of such an event occurring againWhile it is certainly within the realm of possibility, there are several factors that suggest the situation today differs considerably from that previous downturn.

To start, during the turbulent end of 2022, deposit rates were relatively high, with rates for three-year large denomination time deposits sitting at 3.25%. Money that flowed away from bank wealth management and pure bond funds could easily find refuge in more attractive deposit accountsA surge in deposits was indeed observed at the beginning of 2023 as wary investors sought stability.

In contrast, current deposit rates for similar time deposits generally fall below 2.4%, and the issuance volume for three-year large denomination time deposits is minimal, indicating a concerning trend of outflow of savingsThis shift reflects a different sentiment in the market, as investors appear less inclined to leave their funds in low-yielding instruments.

Furthermore, borrowing rates have significantly decreased

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For example, at the end of 2022, the mortgage rate for first-time home buyers in Shanghai was approximately 5%, while it has now decreased to around 3.4%. Given that banks perceive loans as riskier endeavors compared to government bonds, it is expected that mortgage rates would naturally exceed those of government bondsConsequently, it becomes challenging for long-term government bonds to yield more than 3% under the current conditions.

Lastly, the central bank seems committed to lowering the financing costs for the real economyThis goal suggests that it will not allow long-term government bond yields to rise excessivelyShould yields begin to climb too high, the central bank has indicated readiness to directly purchase government bonds to stabilize the market, a tactic that was not available in late 2022.

As investors navigate this turbulent bond market phase, it is crucial for those involved in bank wealth management and bond funds to confront the waves of volatility head-onA proactive approach to understanding the market dynamics is essential as they grapple with yield fluctuations that inevitably impact net asset valuesInvestors should come to terms with the fact that such fluctuations are a fundamental part of the investment landscape.

Considering the limited potential for further interest rate hikes, the anticipated losses in value for these two categories of products are unlikely to be extremeThe yields from bonds can provide adequate compensation for holding these investments strategically over the long term.

Moreover, a tactical shift to shorter-term products might be advisableGiven their higher sensitivity to interest rate movements, converting holdings in mid- to long-term products into short-term equivalents might provide a shield against potential lossesAlthough this switch may yield lower returns, it could decrease exposure to significant value declines.

Investors should resist the temptation to abandon the market following temporary downturns

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