Report Title: How to Understand Central Bank Debt Borrowing? -- Interest rate bond observation on July 1, 2024
Report release date: July 1, 2024
Analyst: Zhang Xu Practicing Certificate No.: S0930516010001
1. How to understand the central bank's treasury bond borrowing?
Today (note: July 1, 2024), the Open Market Business Operation Office of the People's Bank of China (PBoC) issued Open Market Business Announcement [2024] No. 2, announcing that "in order to maintain the stable operation of the bond market, on the basis of prudent observation and assessment of the current market situation, the PBOC has decided to carry out treasury bond borrowing operations for some primary dealers in the open market in the near future". Obviously, the main purpose of the central bank's borrowing of treasury bonds this time 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.
Since April this year, the central bank has carried out many expected guidance on the trend of long-term bonds and ultra-long-term bonds through the Financial Times and other media, and successfully stopped the rapid downward trend of yields since the beginning of this year. Recently, however, bond yields have fallen back to lower levels again. For example, in the previous session (note: June 28), the yield on 10Y and 30Y Treasury bonds fell to 2.21% and 2.43%, respectively.
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.
In the early stage, investors who were long long-term and ultra-long-term interest rate products in the market generally believed that the central bank did not have enough tools to push the corresponding term yields upward. In our view, the attitude of regulators is more critical than the use of specific tools. In our June 19, 2024 report, "The Benefits of Prospective Guidance," we stressed that "in many cases, the operational hurdles that we are making are not a big deal in the eyes of regulators." For example, some investors used to think that the central bank did not hold too many long-term and ultra-long-term bonds, and was probably in a situation where "there is no debt to sell". The central bank easily defused these so-called obstacles by borrowing government bonds.
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.
Some investors believe that the size of a single loan 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.
The central bank has a clear attitude of correcting and blocking the accumulation of risks in the financial market, has sufficient tools and rich experience, and at this time, we do not need to question the willingness and ability of the central bank to guide the long-term bond yields upward, let alone "wrestle hands" with the central bank in the market. We believe that under the continuous guidance of policy, the market will price interest rate products more reasonably, and long-term Treasury yields will eventually return to a reasonable range that matches long-term economic growth expectations.
It is worth mentioning that 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. In the fourth quarter of 2022, the annualized growth rate of the net value of the weighted units of short-term pure bond funds, medium- and long-term pure debt funds, hybrid bond primary funds and hybrid bond secondary funds was -0.10%, -1.21%, -3.81% and -5.20%, respectively.
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. (Note: For a more detailed explanation, please refer to our report of 14 June 2024, "Keeping an eye on the volatility of the bond market".) At this time, investors need to start to respond to the price fluctuations of bond-like assets in advance in order to protect their "money bags".
2. Risk warning
Irrational expectations trigger rapid market volatility.
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