As we step into 2025, the bond market has demonstrated a noteworthy trend, with the continued rise of bond prices amid some economic uncertaintiesThe yield on 10-year government bonds briefly fell below 1.6% in the first week of the year, maintaining this level on January 3. Concurrently, yields on 30-year bonds also dipped below 1.85%, indicating a persistent downward trajectory for bond yields that seems resilient against potential adversities.

Analysts seeking to decipher the driving forces behind this bond market surge note that the underlying economic fundamentals are still in a phase of cautious recuperationEven with expansive monetary policies contributing additional leeway, expectations for both interest rate cuts and reserve requirement reductions linger in the airThis narrative hints that the prevailing bullish sentiment in the bond market remains largely unchanged for now

However, observers warn of potential market disruptions, citing that the market has overly anticipated these cuts which might lead to volatility in bond yields as various macroeconomic factors come into play, including financing conditions, government debt supply, institutional investment patterns, and the entrance of new capital into the market.

Bond Market Resilience

The strength of the bond market was particularly palpable during the first week of 2025. Strikingly, on January 2, the first trading day of the year, yields for both long and short-term government bonds saw a general declineFollowing this trend, January 3 witnessed an unexpected boost for bonds, even as the stock market faced a significant downturnThe unshakeable support from institutional buying became evident, suggesting a bullish outlook characterized by renewed confidence among investors.

The sustained rise in the bond market has been substantially influenced by concentrated trading by institutional investors

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According to a bond trader interacting with Chinese brokerage media outlets, the enthusiasm for trading remained robust, highlighting a trend primarily led by investment funds, which are consistently increasing their positions and extending duration within their portfolios.

Wang Guanjun, a fixed-income analyst at Shanxi Securities, concedes that the prevailing market trends are closely tied to the phenomenon of institutional solidarityOn one hand, the central bank's accommodative monetary policy has furnished investors with ample liquidityOn the other hand, with no recent rate cuts to signal immediate monetary loosening, there is a distinct sentiment among institutional investors who are anticipating future policy shifts that could lead to further easing.

In addition, recent downturns in the stock market have heightened the equity-debt trade-off, encouraging even more investors to fortify their bond allocations to navigate the uncertainties posed by falling stock prices

According to Wang, this strategic shift has provided crucial support behind the rising bond prices.

The bond market has also received significant backing from the economic fundamentalsSince last September, regulatory interventions aimed at capital pricing have been frequentFor instance, the introduction of a self-disciplinary mechanism for market interest rates in November provided guidance aimed at lowering both non-bank deposits and interbank deposit ratesFurthermore, the central bank's vast purchasing operations at the end of December instilled renewed confidence in the market, indicated by significant liquidity injections aimed at stabilizing financial conditions.

Despite this not being the direct rate cut anticipated by market players, its effect on liquidity provision has nonetheless been robust

When analyzed against the central bank's statistics from November, this net liquidity injection could equate to a 25 basis points reduction in reserve requirements, underscoring the immediate forces behind the uptick in bond prices.

Prolonged Liquidity Support

On January 3, the People's Bank of China disclosed that a monetary policy committee meeting had taken place on December 27 to chart future policy directionsThe focus of this meeting was on intensifying monetary policy controls while enhancing both the foresight and effectiveness of such measures.

The primary takeaway from these discussions was the inclination to potentially lower reserve requirements and interest rates depending on both domestic and international economic indicatorsThis strategic observation has led market participants to universally perceive that the prevailing environment of liquidity support is not expected to alter anytime soon.

Reflecting on historical patterns, analysts believe that the bank’s probability of initiating a reserve ratio reduction between December and the February Chinese New Year is relatively high

Thus, there is a strong likelihood of seeing reductions of 25 to 50 basis points, which could alleviate pressures on financing costs and further influence interest rates on bank certificates of deposit.

Conversely, should no immediate cuts materialize, it is anticipated that the central bank will deploy various instruments—including reverse repos and medium-term lending facilities—to stabilize liquidity conditions, despite the challenges posed by persistent pricing pressuresUnder these circumstances, a stable financial environment seems plausible, albeit marred by pockets of pressure on interest rates within layers of the market.

Optimistic sentiments prevail for the short-term liquidity landscape leading up to the Lunar New Year, especially considering a modest scale of local government debt issuance planned at approximately 1150 billion yuan

The overall supply pressures appear manageable, and with a backdrop of suitably loose monetary policy statements from the central bank, there seems to be a widely held belief that the protectionist stance for the markets will remain.

With respect to the measures for achieving liquidity support, predictions suggest that a rate cut, while perhaps delayed, remains a feasible outcome pre-festival, and the introduction of new tools for liquidity provision by the central bank are anticipated to enhance market stability, albeit less effectively than direct cutsThrough these mechanisms, the central bank aims to maintain stable liquidity through the dual challenges posed by significant supply pressure and upcoming MLF expirations in November and December.

Short-Term Volatility: Expectation Management

Despite the positive long-term outlook for the bond market, there are signs of emerging caution among various institutions

As per feedback from bond market practitioners, many are adopting a more conservative approach, indicating that the current market may possess limited upward potential, thus favoring timely portfolio reductions.

Yanzhiqi, an analyst from Huatai Securities, reiterates that the bullish sentiment observed last week was largely propelled by investment funds, while other institutional players exhibited signs of hesitancyTransactional insights reveal that primary buying activity stemmed mostly from these funds, whereas the broader institutional buying interest has been lackluster.

He noted that insurance companies have not significantly increased their exposure to 30-year bonds, maintaining more conventional investments in local debt, and large banks also reflected a slight slowdown in their eagerness to extend duration.

It is important to acknowledge that excessive speculative activities within the bond market may drive leverage levels too high, potentially prompting regulatory actions that could induce alarming market fluctuations