In the world of finance, a significant event has taken place that has both analysts and investors on high alertThe drop of the yield on 10-year government bonds beneath the crucial 2% threshold marks a moment of reflection for the marketAs this yield descends further to 1.74%, traders are beginning to toss around phrases steeped in humility yet tinged with gravity—“a career yield of under 200 basis points” has once again become a point of banter among bond dealers.

“The pace of improvement is astonishing, yet truly shocking at the same time,” remarked a bond market professional in a conversation with a reputable financial news outletParticularly since December, the market's performance has exhibited a fluidity that resonates with elegance, akin to “the flow of clouds and water.”

Since November, as institutions have begun to preemptively adjust their strategies according to expectations of interest rate cuts and to strategically position themselves for the following year's yield assets, the bond market's yield rates have decidedly embarked on a downward journey

Recently, buoyed by signals indicating further relaxation of policies, the sentiment of buying into the bond market has surged once again, leading to new lows for the 10-year government bond yields.

Experts approaching this situation from a variety of institutional fronts have been analyzing these developmentsThey point out that with the current inflation levels in China remaining low, there is indeed a prevailing demand for further reductions to real interest ratesAs the central bank implements methodologies like lowering reserve requirements and interest rates, this progressive easing may further drag the central tendency of broad interest rates downThere are predictions that the yields of 10-year government bonds may still have ample room for declineNonetheless, some analysts caution that after reaching such historically low yields, profit-taking sentiment in the bond market might gradually mount, increasing the resistance against further declines.

The Accelerating Decline of Bond Yields

Since October, the trend has indicated that yields on bonds, particularly the 10-year government notes, have been in a descending channel

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However, starting from November 18, the speed of this downward trend has acceleratedIn the latest trading sessions, the bond yields have plummeted with remarkable rapidity, crossing significant milestones—1.9% and 1.8%—and now the 1.7% mark is precariously within reach.

In shedding light on the factors prompting the bond market downtrend, an investment advisor from Guojin Asset Management elaborated that the current swift decline in bond yields can be attributed primarily to two triggering elements:

Firstly, guidelines have now been established for non-bank peer-to-peer interbank deposits, mandating that they be referenced against the operational rates of 7-day reverse repos in the open market to rationally set interest levelsConsequently, this policy reform effectively streamlined the conduit for monetary policy rates

Following this announcement, the rates for non-bank interbank deposits dropped by about 20 to 30 basis points, causing interbank certificates of deposit to rapidly decline to 1.7%, opening the pathway for short-term yields in the bond market to descend.

Secondly, since 2010, the Central Economic Work Conference has persisted in designating monetary policies as “stable.” The recent shift towards “moderately accommodative” policies possibly hints at substantial easing measures next year, providing leeway for future reductions in policy rates which, in turn, influenced bond yields to fall sharply.

Senior fixed income analyst from Huajin Securities, Niu Yi, conveyed a parallel opinion, noting that OMO (Open Market Operations) and LPR (Loan Prime Rate) have both seen reductions this year

Outstanding mortgage rates have kept pace rapidly, but the trend towards fixed-term deposits has created a disconnect, leading to a rapid decrease in asset yield compared to liabilities, which exerts pressure on banks’ net interest marginsWhen rates for interbank deposits and corporate deposits are lowered, the cost burden on banks diminishes, thereby stoking demand for bond allocations.

“The previous smooth downward trajectory of the bond market aligned with post-December 9's meeting that set the groundwork for a moderately accommodative monetary policy,” Niu expressedSince this is the first instance of a policy turn towards modest accommodation since 2011, it has noticeably increased the anticipation for cuts in reserve requirements and interest ratesHowever, as the market reacts, one must note that institutions' self-learning tendencies are igniting faster trading rhythms and heightened early entry behaviors.

A Clear Pattern of Institutional Rush

“Every day, I watch the market with both hope and unease,” indicated the mentioned bond market participant, reflecting on the market's fluidity

Although the yields falling below 2% or even 1.9% were expected fundamentally, the pace has been quite surprising, with clear signs of institutions racing ahead.

Various institutional studies have echoed similar sentiments, asserting that a core driver behind this impressive trend is indeed the anticipation of forthcoming interest rate cuts.

Funds are perceived to be among the quickest segments of capital during this wave of activity.

“In recent years, while bank funds have bolstered the explosive expansion of fund sizes, they have also increased the vulnerabilities on the liabilities sideWhen market volatility occurs, they are more susceptible and thus necessitate greater strategic interaction, playing a vital role in the marginal pricing across varied assets,” explained Tan Yiming, Chief Strategist at Minsheng Securities

Since November, fund acquisition capacities have ramped up, with increased purchases in rate bonds, credit bonds, and perpetual bonds, while simultaneously reducing holdings of deposits, leading to relative elongation in the duration of bond positions.

Research from Zheshang Securities has illustrated that since November 21, amidst the declining yields, both funds and other non-bank products—along with wealth management and insurance—have actively participated by acquiring sizable quantities of bonds in the secondary market, highlighting that funds alone accounted for approximately 465.5 billion yuan in bond purchases over the last month.

“The influence of funds on the market is indeed interlinked with the favorable bond market performance over the past two years, as copious capital has flowed into bond funds, with continuing investments noted recently,” added the aforementioned market participant

“Some investors are leveraging funds to purchase bonds and have actively increased their positions during favorable conditions.”

Institutional Debate Surrounding Future Potential

Following this rapid ascent, various institutions hold disparate outlooks concerning the future prospects of the bond marketLin Lian assessed that with current inflation levels in China remaining low, the demand for reducing real interest rates persistsWith the continuing descents from the central bank regarding rates and necessary measures, there remains potential for further drops, suggesting that the yields on 10-year government bonds may still experience downward room.

Feng Lin, Execution Director at Dongfang Jincheng Research, echoed this view stating that, in the medium term, given the moderately accommodative stance of monetary policies, significant cuts can be expected, thus allowing further declines in rates

It is anticipated that next year, 10-year bond yields could oscillate between 1.5% and 1.6% take a downward average.

However, some analysts voice a more conservative stanceDongwu Securities has highlighted that the active yield rates on 10-year bonds have already dropped to 1.77%, and 30-year bond yields fell beneath 2% temporarilyIn such extreme circumstances, expectations of easing measures from December’s meetings and the subsequent Central Economic Work Conference significantly influence investors’ perceptions concerning the monetary policies into the next year.

“From a short-term perspective, we foresee that the 10-year government bonds could oscillate within the 1.8% to 2.0% range, with limited space for further declines,” conveyed Niu YiHe noted how this year’s bond market performance has been molded by fundamental dimensions, policy changes, and institutional behavior