The year 2024 in the bond market can be best described by the phrase “beyond expectations.” The bond market has seen tumultuous changes over the past year, starting with a bullish phase, moving into a period of fluctuations, and again returning to a bullish trendAs December approached, the sentiment began to sway heavily toward bonds – with the yield on 10-year government bonds dropping from 2% to below 1.8% and even the 30-year bonds trading under 2% for the first time in a significant time.

This wave of bullish sentiment has led to many bond funds hitting record highs, with data from Wind indicating that out of 6,905 funds categorized as bond funds, 3,250 set new all-time net asset value records by December 16. Notably, some funds, such as the Everbright Mid-High Grade Bond, the Pengyang China Bond - 30 Year Government Bond ETF, and ICBC Ruiying 18 Month Open-End Bond, all boasted annual returns exceeding 20%.

However, the persistent bull run has raised concerns among investors regarding the diminishing “cost-performance ratio” and increased volatility of the bond marketAs we stand at this crossroads, a pressing question arises: Is it still worth investing in bond funds?

Institutional investors have been notably eager to snatch up bond fundsRecent statistics show an uptick in bond fund issuancesAccording to data compiled by Wind, a total of 42 new funds were established in December alone, with an aggregate issuance of 74.29 billion yuan, with bond funds accounting for over 80% of this capital influx.

During this period, bond funds have emerged as the star performers in the market, with 11 funds raising over 5 billion yuan each, and all of them being bond fundsMost of the subscriptions came from institutions, evident from the fact that the effective number of subscribers for many of these funds was under 1,000. This suggests a significant preference among institutional investors to capitalize on current market conditions.

Industry analysts attribute the surge in bond fund popularity to both market-driven factors and a specific phenomenon termed the “calendar effect.” According to GF Fund Management, this “year-end profitability trend” has been consistently observed since 2019, where bond yields exhibit a noticeable decline in December, benefiting those holding bonds with potential capital gains.

“The fundamental reason behind the potential for capital gains in December is that institutional investors need to prepare for a strong start in the following year,” GF Fund explained

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By aligning product issuance with market timing, they aim to buy bonds before the New Year when prices may soar, leading to a rush of end-of-year purchases to amplify buying power.

Moreover, analysts from Morgan Stanley have noted a significant shift in bond market movements, with major yield curves surpassing previous lows and a continued bullish trend closing the yearFollowing the market fluctuations seen in October and November where institutions adjusted their strategies markedly, the end of the year saw various market players such as brokerages, funds, banks, and insurers buying bonds in succession.

Yet, despite this institutional enthusiasm, there remains a cloud of skepticism surrounding the market's current dynamics, as reports suggest a growing concern regarding the bond market’s value proposition and increased volatilityLongcheng Securities highlighted in their research that there is an alarming level of extreme sentiment and excessive trading practices within the bond marketActions taken by investors appear overly aggressive, rendering traditional market indicators nearly ineffective, leading to frequent and significant breaches of critical yield levels.

“Current conditions reflect an excessively aggressive bond marketWe previously noted that, base on the pace of interest rate cuts, the reasonable range for the 10-year government bond yield should be around 1.8% to 1.9%. The fundamental data is already fully accounted for in current pricing, and the market is largely driven by emotions and institutional behaviors,” Longcheng Securities remarked.

Their analysis cautioned that bond investments currently present a notable gambling complexion, with investors racing to position themselves ahead of potential market movements, entering a spiral of competition and preemptive buying that may lead to new lows in the short termHowever, they anticipate that new points of market contention will arise following this extreme trading, warning of brief pullbacks after intense trading periods.

Looking ahead, Zhongou Fund's outlook on the bond market emphasizes that the direction of purchases remains unchanged, especially against a backdrop of moderately relaxed monetary policy and the absence of detailed fiscal guidelines

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They suggest that substantial disturbances are likely to emerge from upcoming first-quarter data and the concrete fiscal measures stemming from the National People's Congress.

“In the short term, we have seen bond markets experience aggressive positions, with both the 10Y and 30Y yields dropping below 2%. However, these lower yields now trend close to the funding costs faced by banksThe pricing in of further interest rate cuts appears largely fulfilled, indicating a shift in market momentum from unilateral downward trends to increased volatility,” Zhongou Fund noted.

Jinying Fund commented on the recent introduction of new policies in the bond market, suggesting this has temporarily curbed previous downward pressuresUnder the current stance of maintaining liquidity from the central bank, the issuance of government bonds this year has not significantly impacted liquidity, indicating a generally favorable environment for bonds remains intact.

“In a climate of bullish sentiment toward the bond market, the continuous breach of key levels by the 10-year government bond signals a potential limitation on the downward scope for yields in the short termHowever, the rally in credit bonds is likely to persistOver the long haul, fund dynamics could further decline with any policy rate reductions or reserve requirement adjustments, given ongoing uncertainties surrounding the effects of new policies, thereby suggesting a need for careful duration management and potential profit-taking,” Jinying Fund elaborated.

As for prospects for the bond market in 2025, Tang Hailiang advises that timing will become increasingly criticalThe ongoing upward trajectory in bond prices appears to be sustainable, as loose monetary policies precede broader credit relaxationExpectations are set for further decreases in price levels within a lightly constrained economic environment devoid of prior rapid growth in sectors heavily reliant on capitalOverall, this may lead to enhanced stability in fundamental market conditions.

Simultaneously, the bond market may increasingly face challenges stemming from low static yields coupled with elevated volatility, as tighter spreads between yields yield a prevalent presence of low-interest characteristics across various classes of debt instruments

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