The bond market's biggest fear during a series of major adjustments: fiscal policy + redemption feedback

Key Points

On September 29th, the bond market continued to adjust significantly, with concerns about fiscal policy and redemption feedback being the main focus of the market. On one hand, uncertainty surrounding policies deepened market concerns about policy disturbances, with fiscal policy being the core focus going forward; on the other hand, redemption feedback from "wealth management - bond funds" could potentially trigger an over-adjustment in the bond market.

Looking ahead, we have several considerations: 1. Regulatory authorities are committed to avoiding redemption feedback; 2. Rationality and emotions clash, trading expectations are not entirely reality; 3. In terms of operations, emphasizing variety selection + short-term trading > duration strategies. It is preferable to position on the left side during adjustments, especially for allocation plates. For allocation plates, yields above 2.2% for 10-year government bonds can be more positive. Medium and short-term credit bonds, commercial paper bonds, and certificates of deposit can still be allocated during adjustments, with stronger certainty. Individual bonds that can play policy games in the short term and do not lose credit benefit significantly, and can still be held in the short term.

Specifically:

On September 29th, the interbank bond market opened after a holiday, and the bond market continued to be weak, with interest rates rising and then falling sharply in the morning session. By noon, 10-year and 30-year government bonds rose by 4bp and 6bp to 2.22% and 2.39%, respectively, while 1-year AAA interbank certificates of deposit rose by 5bp to 1.93%, and 5-year AAA- perpetual bonds and AAA credit bonds rose by over 10bp. At 10 am, 10-year and 30-year government bonds rose to 2.26% and 2.43% at one point. What is the market worried about? Fiscal policy and redemption feedback.

Firstly, policies have not yet been fully implemented, and uncertainty has deepened market concerns about policy disturbances, with fiscal policy being the core focus going forward.

1. How big can the scale of fiscal intensification be? Let's consider it from three levels: The first level: a plan to restructure local government debts of 10-20 trillion + a long-term mechanism [very unlikely]. The second level: filling the gap between the rights and financial powers of local governments in the past five years [low probability]. The third level: around 2 trillion or less, only filling this year's gap plus bank capital injections, new productive uses, etc. [relatively high probability].

2. In terms of tools, the probability of increasing deficits (general bonds) and special national bonds is high, accelerating local government bond issuance and expanding uses are already in progress, the possibility of policy finance coming out still has variables, and a long-term mechanism that can be implemented has not yet been found.

3. The main impact paths of the bond market are threefold: fundamental expectations, currently more focused on risk prevention, the contribution to economic growth still needs to be observed; bond supply, if concentrated in the fourth quarter issuance, will face greater supply pressure, especially for long-term interest rate bonds; liquidity, during the issuance process, there is often a tightening effect on funds, but the central bank can provide hedging.

4. In terms of timing, pay attention to whether there will be relevant information before and after the National Day holiday, and the National People's Congress meeting in mid to late October.

In addition, there has been a shift in real estate regulation and policy direction. The press conference on September 24th proposed reducing the interest rate on existing home loans by 0.5 percentage points, and lowering the down payment for second homes to 15%, among other policies; the Political Bureau meeting on September 26th introduced a new concept of "promoting the stabilization of the real estate market" and phrases such as "strictly controlling incremental changes, optimizing existing stocks," and "adjusting housing purchase restrictions" all exceeded expectations, indicating a major shift in regulatory thinking In addition, the market is anticipating a combination of real estate policies to be introduced soon, including new shantytown renovation, special bond collection and storage, and building maintenance.

Secondly, the redemption feedback of "financial management - bond fund" may trigger an over-adjustment in the bond market.

Currently, the redemption feedback has not started, and further observation is needed after the holiday. Based on the conditions for redemption feedback, when fundamental or policy factors that determine the market trend reach a turning point, coupled with high market fragility, net asset value decline, and other conditions, large-scale redemption feedback often occurs. At present, these conditions are on the edge, with significantly reduced economic tail risks, a decrease in net asset value, but to a limited extent.

In terms of the bond market adjustment range that can be resisted by the low volatility of financial management and accumulated floating profits, 20 basis points may be a watershed.

In the questionnaire survey "Finding Opportunities from 'Common Sense' - September Bond Market Questionnaire Survey" on September 21st, 44% of investors believe that the accumulated floating profits and low volatility mode of financial management can withstand "10-20 basis points" of bond market fluctuations, while 39% of investors choose "20-30 basis points". Of course, in reality, different financial management low volatility protections have different capacities to withstand market fluctuations, but 20-30 basis points may be the maximum tolerance range perceived by the market. From the current bond market adjustment range, the 10-year government bond has risen by 20 basis points from its previous low.

Of course, the redemption motivation is not only short-term net asset value adjustments, but also a small amount of funds redeeming and shifting to the stock market, which may also be a reason for redemption. However, the scale of such funds is currently not large, and the expectation of the sustainability of the stock market trend in the future is crucial.

The good news is that it is currently just before the National Day holiday, and the interest income during the holiday period can offset some of the net asset losses. If there is no rise in the stock market after the holiday, the intensity of redemption feedback will be limited. Of course, once a feedback loop occurs, the bond market may temporarily deviate from fundamental logic, similar to the over-adjustment at the end of 2022, but it will be an opportunity for allocation.

Regarding the future market, here are a few of our thoughts:

1. Regulatory authorities are committed to avoiding redemption feedback.

The central bank and other regulatory authorities are committed to preventing risks such as redemption waves. For example, during the minor redemption turbulence in late August, the central bank responded promptly (easing liquidity, guiding market makers to conduct normal market making, etc.) to prevent the reinforcement of feedback loops. In the early trading session on September 29th, the 10-year government bond once rose by more than 8 basis points to 2.26%, and the 30-year government bond rose by more than 10 basis points to 2.43%, followed by a decline in yields, mainly due to purchases by large banks and insurance companies. It is relatively reasonable for insurance companies to be underweight and increase positions during adjustments, and to some extent, regulatory attitudes can be analyzed from the behavior of large banks. In addition, if the market is over-adjusted, it is worth paying attention to whether monetary authorities will openly buy long-term government bonds when the market adjusts, both to inject liquidity and to prepare for future bond sales. Of course, the trend of fundamentals and the stability of the bond market itself are key, and hope should not be solely placed on the protection of monetary authorities.

2. Rationality and emotions clash, trading expectations rather than reality.

What is reality? Policy interest rates have been lowered by 20-30 basis points, the real estate policies that have been issued are aimed at "stabilizing instead of rebounding," fiscal reinforcement is still pending, and the risk appetite for risky assets has been significantly boosted in the short term The tail risk of the fundamentals has decreased, and the upward momentum is still not clear.

What are the expectations or concerns? The combination of policies has not been fully implemented yet, especially focusing on the fiscal strength. Redemption feedback is still triggering at the edge.

The above "reality" is positive for the short end, the term spread needs adjustment, there is some pressure on the long end, and the curve is steep. However, under the emotional trading caused by "expectations," coupled with the unrealized gains formed over the past three years, caution is needed in the short term. Eventually, it will return to the fundamentals, but in the short term, it is difficult to withstand the impact, and the "top" of interest rate adjustments is unpredictable.

3. Our operational suggestions.

First, reiterate that variety selection + short-term operations > duration strategy. The steep curve is more certain, and the ultra-long-term interest rate bonds and credit bonds were relatively crowded before, requiring more drastic expectation adjustments. Currently, the 30-10 year term spread has returned to 20bp (previously 10bp, obviously too low).

Second, should we act on the left or wait on the right? We tend to choose the left side for adjustments, especially for the configuration plate. In the case where the transition of economic momentum, corporate financing needs, supportive monetary policy, and significant configuration pressure remain unchanged, panic sentiment is more likely to provide opportunities in the medium term. Of course, if fiscal policy exceeds expectations, a reassessment is needed.

Third, for the configuration plate, being more positive above 2.2% for the 10-year government bond. The main consideration is that from March to May this year, the fundamentals are not bad, manual interest rate hikes have not appeared, and the 10-year government bond has not significantly exceeded 2.3%. Considering that the OMO policy interest rate has been lowered by 30bp compared to the first quarter, and the deposit interest rate has rapidly declined after the manual interest rate hikes were stopped, 10-year government bonds at 2.2-2.3% already imply many negative factors.

Moreover, looking at the spread between the ten-year government bond and interbank CDs, as well as the one-year government bond, 2.2-2.3% is already a reasonable level. Of course, the uncertainties of redemptions and other risks limit the extent of operations, and adjustments present opportunities in the medium term. Fourth, medium to short-term credit bonds, commercial paper bonds, and CDs can still be adjusted for opportunities, with stronger certainty. Individual bonds such as convertible bonds that can play the policy in the short term and not lose to credit bonds benefit significantly and can still be held.

Author: Zhang Jiqiang (0570518110002), Qiu Wenzhu, Wu Yuhang, Source: Huatai Ruisi, Original Title: "Huatai Fixed Income: Bond Market Severe Volatility: Rationality and Emotional Confrontation"