An article to understand the borrowing operation of the central bank's treasury bonds

Wall Street Sights

2024-07-02 08:57Wall Street News Official Account

Against the backdrop of long-term interest rates continuing to fall, the central bank intervened intraday on Monday and announced that it would carry out "treasury bond borrowing operations".

Treasury bond futures dived in response, with 30-year Treasury bond futures closing down 1.1%, after rising more than 0.39% and hitting a record high, and recently the 30-year Treasury bond began to test the 2.4% year-to-date low again.

In fact, the central bank's action this time is not unexpected, since April, the central bank has publicly "shouted" on long-term bond interest rates more than ten times in a row, and the Lujiazui forum also indicates that the tools for buying and selling treasury bonds will be launched.

So how do you understand this operation? In terms of trading volume, how many Treasury bonds are available for central banks to borrow? Historically, what lessons are there to be learned?

More importantly, what is the impact on the bond market? Will it be the end of this round of debt bulls? What does this mean for bond funds?

What are the details worth noting?

From the perspective of time, Minsheng Macro Tao Chuan pointed out that the central bank rarely announced the "treasury bond borrowing operation" in the intraday, which reminded people of the last intraday shot to stabilize the exchange rate (the foreign exchange self-discipline mechanism meeting + financial data was released at noon on September 11 last year).

Tianfeng Fixed Income pointed out that first of all, the central bank made an operation announcement on July 1, which may have deliberately avoided the important time point of the end of the first half of June. If the announcement had been made in mid-to-late June, the impact on the bond market would have been different. Second, the central bank has not significantly increased liquidity withdrawal for the time being, indicating that there may still be some care for the market.

In terms of content, Huatai Securities pointed out that this announcement was issued on the official website of the central bank as "Open Market Business Announcement [2024] No. 2", and the column was previously published as a list of primary dealers. This means that Treasury borrowing is a new instrument, which is different from previous models such as positive repo and bill swaps.

What happens after borrowing? There is a high probability that it is to be sold.

Huatai Securities pointed out that the central bank has made it very clear that "in order to maintain the stable operation of the bond market", so there is a high probability of selling. Specifically, let's do it:

Analogous to bond lending, the central bank should borrow and sell the bonds in the current period, buy and repay the bonds in the future, and the interest during the period belongs to the lender. It is equivalent to increasing the supply of the secondary market in the short term and increasing the demand of the secondary market in the future, but in fact it depends on the borrowing period and the operation of the central bank after maturity.

Everbright Securities also believes that it is obvious that the main purpose of the central bank's borrowing of treasury bonds is to sell them at an opportune time in the future, release monetary policy signals, promote the balance between the supply and demand of long-term interest rate goods, and guide the yield of long-term treasury bonds upward. Everbright Securities pointed out:

Some investors believe that in the future, the central bank will eventually return the bonds it borrowed, so the central bank will buy them back in the market, and the purchase of bonds will push yields down again. We think this is true, but this is a matter of the distant future, not a key factor in the current market movement. Moreover, the timing of buying bonds is grasped by the central bank, and it is likely to choose to buy when the yield is too high.

How many treasuries are available for central bank borrowing? What are the lessons learned?

Secondly, trading volume is key.

Huatai Securities pointed out:

At present, the single-day secondary trading volume of treasury bonds is between 400 billion and 500 billion, so if the central bank wants to affect interest rates by selling, the scale of operation cannot be too small, even if it is less than 100 billion, it will need tens of billions. If it is less than 10 billion, it is still expected that the significance of guidance is greater than the substantive effect.

According to the custody data released by China Bond, as of May 2024, commercial banks held 20 trillion yuan of treasury bonds, mainly large banks. According to rough estimates, after deducting the demand for pledges and other needs, the treasury bonds available for lending by primary dealers are about 8 trillion. However, the maturity of these bonds is generally not too long.

From the perspective of historical experience, Minsheng Macro pointed out that the newly proposed "treasury bond borrowing operation" is not the mainstream in history. In theory, there are two ways for the central bank to sell treasury bonds in the open market, one is through repurchase, and the other is to sell cash bonds, both of which mostly appeared from 2000 to 2014. The PBOC's expression of "treasury bond borrowing operation" is different from the above two, and we believe that there may be two experiences worth referring to in the mechanism:

The first is the lower edge scenario of the BOJ's YCC. That is, when the yield of long-term bonds hits the lower limit of interest rates, the central bank can sell a large number of treasury bonds, affecting the supply and demand of the secondary market of bonds and pushing up interest rates. However, against the backdrop of Japan's long-term ultra-loose monetary policy, there are not many cases of the BOJ selling government bonds after triggering the lower edge of the YCC.

The second is the previous "stable exchange rate" operation of the central bank of the mainland. Historically, the central bank of the mainland has borrowed US dollars in the forward market and sold them in the spot market to release foreign currency liquidity and hedge the pressure of RMB depreciation. The operation logic of "borrowing first and then selling" may be similar to that of this "treasury bond borrowing".

Is this signal more significant than substantial?

Minsheng Macro pointed out that in this case, the signal may be more significant than the substance:

At the end of 2023, the central bank accounted for 48% of the treasury bond holders, while the central bank of China only accounted for 5%, and the impact of selling treasury bonds on market supply and demand was limited. We believe that the central bank is unlikely to follow the path of "Japaneseization" deficit expansion + large bond purchases in the future, but tends to be close to the previous "interventional" operation to stabilize the exchange rate, so there are more signals to correct the market.

Historical experience tells us that if the market's response to expectation guidance is too flat, the central bank is more likely to increase the intensity of expectation guidance and start to use other policy tools, and finally achieve the "consistency of words and deeds" between the central bank's policy operation and external communication, and maintain the guidance of expectations.

Everbright Securities believes that the attitude of regulators is more critical than the scale of operation:

The size of a single borrowing of Treasury bonds is limited, and even if they are sold all, the impact on the market is limited. We need to reiterate the basic idea that the attitude of the regulator is more critical than the use of specific tools.

In addition, the central bank did not specify that it would only borrow treasury bonds once. If the bond market does not move to the satisfaction of the monetary authorities for some time to come, it makes sense to re-engage in borrowing and selling government bonds, and to use the rest of the policy tools.

What is the impact on the bond market? Will it be the end of this round of debt bulls?

Huatai Securities pointed out:

Phased adjustments are inevitable. First of all, the central bank's borrowing of treasury bonds shows its determination to regulate long-term interest rates, and phased adjustments are inevitable, and the bottom of interest rates is temporarily clear.

However, for bonds, the downward logic of long-term interest rates has not fundamentally changed, and the central bank obviously needs to control the risk of interest rates falling too quickly and stabilize the interest rate differential between China and the United States.

This is similar to the view of Sun Binbin's team of Tianfeng Fixed Income:

We judge that the current macro logic of stable growth and easy money is still in the current situation, so there is no simple reversal in the bond market, the possibility of interest rate cuts is still there, and the overall trend of interest rate decline has not changed. So a full-fledged defense is not enough.

However, from a stage perspective, the short-term may still be biased towards range-bound fluctuations, and the interest rate in the bond market has a top and a bottom. Because the central bank's behavior needs to be further observed, it is not considered to adjust for the time being, that is, buying.

Huatai Securities further pointed out:

In 2016, the bond bull ended with financial deleveraging, and the fundamentals warmed up in the early stage (real estate + external demand). The original intention of the central bank to borrow bonds and sell bonds in this round was not to crack down on financial leverage, but more to "cool down" the bond market. Moreover, the original intention of the central bank is not to make a large adjustment at the long end, because once it triggers a feedback loop or affects fiscal bond issuance, it is not conducive to economic recovery and monetary policy transmission.

From the perspective of curve shape, this operation can also be understood as a yield curve control tool, from the June cross-quarter investment, the central bank does not want to cause short-end capital fluctuations, short-end interest rates are generally stable. The long end may be the focus of regulation, and if the long-term bonds are sold in the future, the curve pattern will tend to steepen.

Overall, the 30-year treasury bond has not yet gotten out of the 2.4%-2.6% fluctuation range we predicted before, and the odds near the lower limit are reduced and we must pay attention to the dynamics of the central bank, and the obvious adjustment is still an opportunity. After all, the fundamental logic (financing demand, real estate, production ratio demand) has not wavered, and for a large number of long-term underallocated funds, as long as the point is high enough, the intermediate fluctuations are only short-term disturbances.

What is the impact on bond assets?

Everbright Securities reminds that it is also necessary to pay attention to the price fluctuations of bond assets:

The rise in yields in the fourth quarter of 2022 triggered a decline in the net value of asset management products such as bank wealth management and mutual funds. The decline in the net value of the fund has been accompanied by a decrease in the share of the fund. At the end of the fourth quarter of 2022, the shares of short-term pure debt funds, medium- and long-term pure debt funds, hybrid bond primary funds and hybrid bond secondary funds decreased by 35.2%, 5.7%, 15.8% and 9.7%, respectively, compared with the end of the third quarter of that year.

Moreover, during that period, there was a mutually reinforcing effect between the decline in the net value of asset management products such as funds and the decrease in share. While the current bond market is not exactly the same as it was before the Q4 2022 correction, there are many similarities. In fact, there are many negative factors at present, but they are ignored by investors intentionally or unintentionally. At this time, investors need to start to respond to the price fluctuations of bond-like assets in advance, so as to protect their "money bags".

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