On April 22, the latest Loan Prime Rate (LPR) was released, revealing an unchanged rate for AprilThe one-year LPR has remained steady for eight consecutive months, while the five-year LPR has not altered over the past two monthsThis stable LPR, as anticipated by market observers, sparked a decline in interbank major bond yieldsBy the close of trading on the same day, the yield on ten-year government bonds dropped to 2.243%, reflecting a decrease of approximately 30 basis points since the start of the year.

The recent trends in the bond market indicate low interest rates coupled with declining volatilityIndustry insiders attribute this to a phenomenon deemed as "asset scarcity," where insufficient credit demand alongside inadequate bond supply diminishes the overall demand for capital, thereby resulting in liquidity being more abundantAs this bullish trend in bonds extends, banks and wealth management institutions are likely to adjust their allocation strategies.

The continued decline in bond yields has characterized the market this year

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As of April 22, the ten-year government bond yield closed at 2.243%, down around 30 basis points since the beginning of 2023. Meanwhile, the thirty-year government bond yield fell over 40 basis points to 2.530%. Similarly, in the credit bond market, the yield on five-year AAA-rated medium-term notes dropped to 2.335%, with the three-year and one-year yields also reflecting downward trends at 2.260% and 2.160%, respectively.

In an interview, a bond trader remarked that the prevailing bullish sentiment in the market follows the significant downward movement in interest rates observed in the first quarter of this year"Factors such as weak economic fundamentals, loose monetary policies, and increased institutional allocation demand continue to drive bond yields lower," he statedNotably, the decline in credit demand alongside insufficient bond supply reduces the overall demand for capital, promoting a more generous liquidity environment.

Recent data from the first quarter reveals the sluggish state of financing demand within the real economy

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Central Bank data indicates that the total social financing (TSF) and the addition of renminbi loans were 12.93 trillion yuan and 9.46 trillion yuan, respectively—meaning there were year-over-year reductions of 1.60 trillion and 1.14 trillion yuanOut of this, the issuance of long-term loans to households and businesses accumulated to 0.98 trillion and 6.20 trillion yuan, with the former seeing a minor increase and the latter experiencing a decline compared to the previous year.

The inadequacy of effective credit demand underpins the bullish trend in the bond market, as industry professionals acknowledge that the internal demand recovery remains weak, making it unlikely for bond yields to rebound in the short termChief economist Mingming from CITIC Securities noted that while signs of economic rebound are now emerging, they are insufficient to alter investors' low-risk appetites

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Concurrently, the bond market continues to experience significant "asset scarcity," suggesting a likely continuation of a bullish market in the near term.

The slowdown in special bond issuance in the first quarter is viewed by industry insiders as another significant factor supporting the decline in bond yieldsAccording to Enterprise Warning data, 634.1 billion yuan in new special bonds were issued in Q1, only accounting for 27.8% of the previously allotted quotaThis indicates a 34.2-percentage point decrease from the 1.35 trillion yuan in special bonds issued during the first quarter of 2023, and a stark 61.1-percentage point drop compared to the 88.9% allocation in 2022.

Market opinions suggest that the reduced issuance of regular and special treasury bonds during the first quarter may be paving the way for long-term special treasury bond offerings in the second quarterYang Yewei, chief fixed income analyst at Guosheng Securities, forecasted an increase in government bond supply over the coming months, which might introduce some supply pressure and alleviate the ongoing "asset scarcity." However, given the central bank's liquidity measures and the anticipated efficiency of government fund allocations being higher than the last quarter of the previous year, it seems unlikely to provoke a trend adjustment in the bond market.

Overall, the dual challenges of diminished credit demand and insufficient bond supply have contributed to the easing of liquidity

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Data indicates that the net lending scale of the banking system decreased from 4.20 trillion yuan on April 12 to 3.73 trillion yuan by April 19. While major banks showed little change in net lending figures, the decreases in shareholding banks’ lending were primarily driven by increased demand from regional commercial banks.

Simultaneously, the central bank has somewhat tightened its net monetary injectionSince the beginning of April, the central bank has injected 130 billion yuan through open market operations while reclaiming 1.05 trillion yuan, resulting in a net withdrawal of 920 billion yuanHowever, signs of improvement emerged as the April tax deadline approached, with last week showing a gradual decrease in net cash withdrawal by the central bank, which pulled back 72 billion yuan and is projected to withdraw 8 billion yuan this week.

Li Yishuang, the chief fixed income analyst at Cinda Securities, noted that despite minor disturbances by the tax period, interbank market funding rates saw a slight increase

Nevertheless, the spread between R007 and DR007 narrowed to 2 basis points, suggesting that liquidity segregation issues are easing, and the overall loose monetary framework remains intact.

The central bank’s minor relaxation of open market operations, combined with the weak institutional demand for funds, has allowed liquidity to sustain its loose trendObservations from repo types in the interbank lending market showed a uniform decline on April 22; the weighted average rate of DR007 fell by 4.24 basis points to 1.8351%, while DR001, DR014, and DR021 also experienced various levels of decreasesOffering insights, the short-term SHIBOR rates dropped collectively, with quotes for three-month variants recently dipping below 2%, while the seven-day SHIBOR dropped by 3.9 basis points to 1.8310%.

In this low-rate environment, shifts in institutional allocation strategies are apparent

The prevailing expectation within the industry is that low interest rates will persist for the foreseeable futureAs one of the broad indicators of interest rates, bond yields have not escaped this trend, with the ten-year government bond yield plummeting from a previous high of 5% down to 2.24%. Many in the sector believe the potential exists for further declines in bond yields.

Faced with these developments, professionals recommend transitioning to strategies that extend duration within portfolio allocationsOne bank representative mentioned to reporters that given the continuing decline in bond coupon rates, previous strategies aimed at simply holding bonds until maturity to capture yields no longer suffice for the current environment"Extending duration" may emerge as a more viable approach.

Specifically, this individual suggested focusing on two main areas: first, targeting municipal investment bonds in developed regions while stretching the duration to 3-5 years; second, considering provincial and rural commercial bank tier-two capital bonds descending from these developed areas, again keeping an eye on the 3-5 year duration spectrum.

According to Xiaojin Chuan, a fixed income analyst at Huaxi Securities, the bond market continues to grapple with extreme supply-demand imbalances