China's fixed income market is currently experiencing a wave driven by both liquidity premiums and an asset shortage. In a macroeconomic environment characterized by loose monetary policy and stable credit, a substantial amount of funds awaiting allocation has accumulated within the financial system, while effective financing demand in the real economy is yet to fully recover. This has led to a substantial inflow of capital into standardized bond assets. Early trading on Friday saw yields on both 10-year and 30-year government bonds decline, and government bond futures closed higher across the board, with the TL2606 contract rising by 0.26%, reflecting institutional investors' preference for extending duration in the current macroeconomic environment.
Transmission Across the Industrial Chain
Within the current transmission chain of the financial system, the PBOC's open market operations have maintained a relaxed liquidity environment, primarily benefiting primary dealers and large commercial banks. With structural constraints on credit issuance, excess liquidity flows to broadly defined funds and non-bank institutions through certificates of deposit and repos. Asset management companies, insurance managers, and mutual funds, facing rigid cost constraints on their liabilities, are compelled to seek returns from long-term government bonds. This transmission of funds from base money to non-bank allocations has directly led to ultra-long bonds like the 30-year bonds becoming a core reservoir for liquidity absorption, thereby depressing risk-free rate benchmarks across the market.
Supply and Demand Dynamics
From a supply perspective, China's Ministry of Finance has not yet initiated large-scale issuances of ultra-long special government bonds, and the issuance pace of local government special bonds remains relatively steady. This relatively restrained pace of asset supply contrasts sharply with the ever-expanding allocation demand from non-bank institutions. The phenomenon of capital having nowhere to go, reported by banking traders in the East China region, epitomizes this supply-demand mismatch. Before any substantial new supply materializes and exerts a siphoning effect on market funds, the asset shortage logic is unlikely to be fundamentally disproven.
Institutional Strategies and Tactics
Faced with an absolute low of 1.771% on 10-year government bonds, institutions are shifting their focus from simple directional trading to spread and curve strategies. CITIC Securities notes that if monetary policy remains unchanged, 1.75% will be the ideal average for 10-year bonds. Under this expectation, institutions are inclined to leverage abundant short-term low-cost funds to invest in ultra-long-term assets with relatively better coupon yields. However, this strategy is highly sensitive to fluctuations in the funding environment; should the central bank withdraw funds more aggressively than anticipated or inflation data stabilize and rise, the crowded long trades may face end-tail risks of a crowded unwinding.
