Joint warning on bond market risks! A central bank official told the media that more attention should be paid to bond price fluctuations. An authoritative figure cited by China Securities Journal stated that bond funds in a "bull market" also carry significant risks

Since the beginning of this year, against the backdrop of overall interest rate declines, the bond market has seen a long-awaited outbreak, especially with high trading activity in long-term and ultra-long-term bonds. Benefiting from the bullish bond market, the returns of some bond funds have increased, with some products even achieving an annualized return rate of over 10%.

How to understand the fluctuations in the bond market?

Recently, with the official issuance and high demand of ultra-long-term special national bonds, the volatility of the bond market has continued to attract attention.

In fact, looking back at history, it is not difficult to find that the Chinese bond market has experienced many rounds of ups and downs since the beginning of 2018. The last significant decline occurred in the fourth quarter of 2022. In September 2022, the average yield of 10-year government bonds was 2.67%, which had risen to 2.87% by December, an increase of 20 basis points within three months.

During that period of rising 10-year government bond yields, the yields of almost all types of bonds increased, with only differences in the magnitude of the increases. The monthly average yields of 1-year government bonds, 1-year policy bank bonds, 1-year AA-grade short-term financing bonds, and 1-year AA-grade subordinated capital bonds increased by 43 basis points, 51 basis points, 112 basis points, and 114 basis points respectively. The monthly average yields of 5-year government bonds, 5-year policy bank bonds, 5-year AA-grade medium-term notes, and 5-year AA-grade subordinated capital bonds increased by 23 basis points, 33 basis points, 57 basis points, and 95 basis points respectively.

These changes also led to changes in the net asset values of asset management products such as bank wealth management and public funds. Data shows that in the fourth quarter of 2022, the annualized post-adjustment unit net asset value growth rates of short-term pure bond funds, medium to long-term pure bond funds, hybrid bond type primary funds, and hybrid bond type secondary funds were all negative, at -0.10%, -1.21%, -3.81%, and -5.20% respectively. Along with the decline in fund net asset values, there was also a decrease in fund shares. By the end of the fourth quarter of 2022, the shares of short-term pure bond funds, medium to long-term pure bond funds, hybrid bond type primary funds, and hybrid bond type secondary funds had decreased by 35.2%, 5.7%, 15.8%, and 9.7% respectively compared to the end of the third quarter of the same year.

The reasons behind the bond market adjustment in the fourth quarter of 2022 were a combination of multiple factors such as fundamentals, valuation, supply and demand, and sentiment. At that time, a series of heavyweight policies were introduced, effectively reversing market expectations to stabilize the economy. In September of that year, the manufacturing PMI once again rose above 50%; in addition, factors such as the significantly overvalued bond market and the emergence of asset shortages also played a role in the previous round of bond market changes.

Looking back at the present, we can also see many similarities between the current bond market and the adjustments before the fourth quarter of 2022.

From a fundamental perspective, as inflation and other indicators recover, investors' expectations for the economic situation are gradually changing. Since the beginning of the year, the CPI has been on a mild upward trend; since March, the year-on-year decline in the PPI has continued to narrow. In May, the comprehensive PMI output index was 51.0%, in the expansion zone, indicating that Chinese enterprises' production and operation activities are maintaining a trend of recovery and development From a valuation perspective, on June 13th, the yield spread between the 10-year government bond and MLF was -22 basis points, while the spread between 5-year AAA-rated bank perpetual bonds and 5-year government bonds was 37 basis points (monthly average). Both of these indicators are significantly lower than the levels in September 2022.

From a supply and demand perspective, bond investors are once again feeling an "asset shortage", especially as it is widely believed that the supply of long-term and ultra-long-term bond varieties is lower than expected. However, it is worth noting that the total amount of government bond financing this year is relatively large, and issuing fewer bonds in the early stages implies that more will be issued later on. The acceleration of government bond issuance since late May will drive a shift in the supply and demand dynamics of the bond market.

From a sentiment perspective, there is generally less focus on bearish factors in the current market. Such views tend to emerge in the third quarter of 2022 and at the end of each bull market cycle, and investors often overly emphasize bearish factors once the adjustment begins.

In addition to these "macro" factors, industry experts have also pointed out some "micro" factors worth noting. For example, the average of R007 in April and May this year has been continuously decreasing, with a 24 basis points decrease in May compared to March. This reflects ample liquidity among non-bank entities, which is one of the reasons why investors have priced the 10-year government bond yield relatively low during this period. However, investors must realize that the "wealth of non-bank entities" is only temporary, not a trend. The impact of measures such as the ban on manual interest rate adjustments leading to liquidity redistribution was initially significant but will gradually diminish. As non-bank institutions allocate assets such as bonds, the liquidity of non-bank entities will gradually return to normal in the future, which may lead to repricing in the bond market.

In conclusion, many industry insiders have warned that there are many bearish factors at present, but investors have intentionally or unintentionally overlooked them. We expect investors at this time to pay more attention to the price volatility risks of bond assets and safeguard their "wallets"