Analysis of bond yields under regulatory policies
2024-08-14
한어Русский языкEnglishFrançaisIndonesianSanskrit日本語DeutschPortuguêsΕλληνικάespañolItalianoSuomalainenLatina
Analysis of bond yields under regulatory policies
Zhang Yi, Chief Economist of Hengtai Securities, He Xiutong, Researcher of Hengtai Securities Research Institute
1. Analysis of the downward trend of 10-year Treasury bond yields since 2023
Before 2021, the 10-year treasury bond yield rose and fell, fluctuating in a range of about 3.5%, and 2.7% was the bottom of the 10-year long bond yield. There was a long period of decline between 2014 and 2016. This was mainly driven by two factors. On the one hand, this period was a period when my country's interest rate marketization reform was actively promoted, and the bond market was also undergoing a repricing process. On the other hand, this period was also a downward cycle in my country's real estate market, with economic growth continuing to slow down and price downward pressure being extremely high. PPI experienced 54 months of negative growth, and monetary policy experienced five interest rate cuts and six reserve requirement ratio cuts. The long-term bond yield also fell by about 200 basis points. Afterwards, with the advancement of supply-side structural reforms and the monetization reform of shantytown renovation, the yield began to rebound. During the epidemic in early 2020, the yield once fell to around 2.5%, but after the lockdown was lifted, the yield rebounded rapidly.
After 2021, the fundamentals of 10-year Treasury yields turned to a long-term downward trend, with two rare rapid declines. The first was from March 2021 to September 2021, from 3.26% to 2.83%, a cumulative decline of 43 basis points. This round of rapid decline in yields was mainly due to the market's strengthening expectations of the central bank's interest rate cuts.
The second time was from November 2023 to February 2024, from 2.7% to 2.33%, a cumulative decrease of 37 basis points. This round of long-term bond yield decline is largely due to the shift in inflation expectations. Inflation expectations are a combination of multiple factors such as economic growth, capital return rate, risk preference and expectations for future macro policies. In 2023, the real estate industry continued to adjust, and the relevant policies to control local debt risks also led to limited financing for local financing platforms. There is a shortage of assets in the market. Under the drag of real estate, the growth rate of the macro economy has further slowed down, and the characteristics of insufficient total demand have become more prominent. Insufficient total demand, declining capital return rate, and at the same time, macro policies have maintained sufficient stability. Under this circumstance, relevant price indices began to decline, especially CPI and PPI showed negative growth. In the last price down cycle, PPI had been negative for 54 consecutive months. The current situation is more severe than the previous cycle. With the continued negative growth of PPI and the sluggish CPI, inflation expectations have changed, which is also the result of changes in growth expectations for the next period of time.
Chart 1: 10-year Treasury yield curve (%)
Data source:ifind, Hengtai Securities Research Institute
II. Reasons and possible effects of the central bank's intervention in the government bond market
1. Reasons for central bank intervention
After the bond market has experienced a continuous decline since 2023, the central bank has continued to remind the bond market of risks since April 2024. The first quarter regular meeting once stated that "in the process of economic recovery, we must also pay attention to the changes in long-term yields." Subsequently, the central bank issued warnings on bond market interest rates on multiple occasions. In the five trading days after April 24, the 10-year Treasury yield rose from the low of 2.22% on April 23 to 2.34%, an increase of 12 basis points; the 30-year Treasury yield rose from the low of 2.44% on April 23 to 2.55%, an increase of 11 basis points. Considering the longer duration of 30-year bonds, their actual price adjustment will also be greater. But a month later, long-term bond interest rates continued to decline. The central bank once again issued a warning, and the central bank governor Pan Gongsheng made it clear: "At present, we must pay special attention to the maturity mismatch and interest rate risk of some non-bank entities holding a large number of medium- and long-term bonds, maintain a normal upward-sloping yield curve, and maintain the market's positive incentive effect on investment." On July 1, the central bank stated in its open market business announcement that "it has decided to carry out treasury bond borrowing operations for some primary dealers in open market operations in the near future."
The reason why the central bank attaches so much importance to long-term government bond yields is not to stabilize the exchange rate as the market believes, but to stabilize the banking system.
In terms of exchange rates, let's take the offshore market, which better reflects market demand, as an example. In this economic cycle, the RMB exchange rate against the US dollar has broken through 7.1 four times. At these four points in time, the level of treasury bond yields was not consistent, which shows that there is no direct correlation between treasury bond yields and the RMB exchange rate. At the same time, at the first three points in time when it broke through 7.1, the central bank did not intervene in the exchange rate by intervening in treasury bond yields. More importantly, when the central bank began to verbally intervene in yields, the exchange rate did not show a strong depreciation trend.
The so-called stability of the banking system is mainly due to two factors. First, the rapid increase in commercial banks' bond positions has formed a stampede effect to a certain extent, which may lead to an overshoot of yields in the short term. Once the yield returns to the long-term equilibrium level, it is very likely to bring losses to banks. Some city commercial banks with larger positions may even face certain risks. From 2023 to date, the scale of treasury bonds held by commercial banks has soared from 15.8 trillion to 20.5 trillion, an increase of 4.8 trillion, and the proportion of holdings in all treasury bonds has also exceeded 70%. Second, from a long-term perspective, there is a strong correlation between treasury bond yields and bank net interest margins. The current bank's net interest margin has dropped to 1.54%, which is lower than the previously recognized bank's break-even point of 1.7%. If the treasury bond yield continues to decline, it may lead to a further contraction of the net interest margin, leading to risks for some small and medium-sized city commercial banks with weak risk resistance.
Chart 2: Offshore RMB exchange rate
Data source:ifind, Hengtai Securities Research Institute
Figure 3: Commercial Bank Treasury Bonds (Trillion)
Data source:ifind, Hengtai Securities Research Institute
Figure 4: Commercial Bank Net Interest Margin & 10-Year Treasury Bond Yield (%)
Data source:ifind, Hengtai Securities Research Institute
2. Effects of central bank intervention
From international experience, the central bank can better control the yield of short-term interest rates by adjusting policy interest rates and liquidity control, but for long-term interest rates, the effect of central bank intervention is uncertain for a period of time. For example, in March 2004, the Federal Reserve began to raise interest rates, and interest rates increased by 400 bp in two years, but the yield of 10-year Treasury bonds did not fluctuate much, and even fell slightly after the Federal Reserve stopped raising interest rates. Similarly, during the international financial crisis, the Federal Reserve implemented three rounds of QE and one round of QT in order to lower long-term bond interest rates. The effectiveness of QE is obvious. Gagnon (2016) summarized the results of 24 quantitative studies from 2008 to 2015 and concluded that: QE of 10% of GDP can reduce the yield of 10-year Treasury bonds by 68bp, with a median of 54bp. However, further research shows that the decline in yields caused by QE operations requires continuous buying. Once it stops, the yield of long-term bonds is very likely to stabilize and rebound to a certain extent. For OT operations, the effect is not obvious.
According to the news, the central bank has borrowed hundreds of billions of treasury bonds from primary dealers, accounting for about one thousandth of GDP. Based on the experience of QE in the United States, this scale of operation has little impact on the yield of long-term treasury bonds, and only has a short-term psychological effect. If the central bank wants to continue to intervene in the treasury bond market, there are two ways to do it. One is to continue to borrow bonds from the market and then sell them. The other is to sell the 1.5 trillion special treasury bonds in hand. Unless in extreme cases, this method will basically not be considered. For the first one, excluding savings treasury bonds and treasury bonds that have been used for repurchase transactions, there are about 20 trillion treasury bonds available for purchase in the market, and 8 trillion treasury bonds available for sale in the hands of primary dealers. In addition, considering the need to manage the positions held by banks, the term of the central bank's credit borrowing will not be too long. At this time, a reverse operation may hedge the effect of the previous operation.
Figure 5: Fed rate hike cycle & US Treasury yields (%)
Data source:ifind, Hengtai Securities Research Institute
3. Further analysis of bond yield trends
The central bank's first quarter monetary policy implementation report pointed out the risk of long-term bond yields, and the second quarter monetary implementation report also pointed out the possible risks of some bond products in the column. At present, in addition to the aforementioned central bank's borrowing and selling operations, the central bank has taken some administrative measures. Judging from the effects of the measures that have been implemented, these policies have had an immediate impact on the market. Under the current situation of insufficient effective demand and downward pressure on prices, it is difficult for the 10-year treasury bond yield to continue to rise, but at the current position, especially when the central bank attaches great importance to the 2.3% level, it is difficult to say that the yield will continue the trend since last year. It remains stable in the range of about 2.2%-2.3%. According to the monetary policy implementation report, there is a possibility of further interest rate cuts and reserve requirement ratio cuts in the future. Under the condition that long-term bond interest rates may be relatively stable, it is more worth analyzing the term spread and credit spread.
1. Short-term yields are more affected by monetary policy
As mentioned above, there are many factors that affect long-term yields, while the main factors that affect short-term yields are monetary policy and the liquidity it affects. For example, during the epidemic, against the backdrop of continuous interest rate cuts, liquidity was released rapidly, and the one-year treasury yield fell faster than the ten-year yield, with the spread reaching 130 BP at one point. Similarly, after the second half of 2023, as the MLF interest rate was lowered, the spread began to widen, from less than 50 BP to 70 BP. Over the past 10 years, the average spread between the one-year yield and the ten-year yield has been 67 BP, so the current spread has not deviated significantly from the equilibrium level.
On July 22, the central bank lowered the interest rate of the standing lending facility (SLF) and the open market (OMO) 7-day reverse repurchase operation by 10 basis points, and lowered the loan market benchmark rate (LPR) by the same amount. On July 25, the People's Bank of China conducted MLF operations in the open market for the second time this month, with an operation volume of 20 billion and a 20 basis point interest rate cut. This operation not only lowered the loan interest rate, but more importantly, by lowering the upper edge of the interest rate corridor, it narrowed the space of the interest rate corridor, which is conducive to reducing the financing costs of banks. Therefore, in the foreseeable period of time, as the interest rate center moves downward, the short-end yield is likely to be further reduced.
Chart 6: Term spread and one-year MLF rate (%)
Data source:ifind, Hengtai Securities Research Institute
Figure 7: Interest rate corridor (%)
Data source:ifind, Hengtai Securities Research Institute
(II) The performance of interest rate spreads of different ratings varies under asset shortage
The asset shortage has led to a decline in the current treasury bond yields. In the context of asset shortage, the yields of high-quality assets have also declined, leading to changes in yields of different ratings. On the one hand, the yields of relatively high-rated bonds have also declined, resulting in a significant narrowing of the spread; on the other hand, for industrial bonds with lower ratings, the spread has shown a trend of first widening and then narrowing.
The most typical high-credit-rating bonds are national development bonds. In the past, the spread between ten-year national development bonds and treasury bonds of the same maturity was between 50-100 BP. In the context of asset shortage, especially when the stock size of national development bonds is weak, the lack of supply has caused the yield of high-grade bonds such as national development bonds to fall faster. At present, the spread has been reduced by less than 10 BP, which is almost negligible. In other words, in the context of asset shortage, the market has basically ignored the benefits brought by the tax offset effect of treasury bonds, and there has been a frantic rush for treasury bonds that are also national credit. For relatively risky assets, credit spreads once widened against the background of strengthened risk appetite. However, in the second half of 2023, as the asset shortage intensified, some funds passively increased the allocation of related so-called high-risk assets, causing the spread to begin to decrease.
If the 10-year Treasury yield maintains a volatile pattern after the third quarter, it is not ruled out that more funds will begin to look for assets with higher risks and relatively higher yields for allocation in the future.
Chart 8: 10-year Treasury bond and public bond yields and spreads
Data source:ifind, Hengtai Securities Research Institute
Figure 9: Net financing amount of government bonds and public debt since 2019
Data source:ifind, Hengtai Securities Research Institute
Figure 10: Yields and spreads of 10-year government bonds and low-grade municipal bonds
Data source:ifind, Hengtai Securities Research Institute
IV. Main Conclusions
First, the decline in real estate further highlights the contradiction of insufficient total demand, and the change in inflation expectations is the main factor for the decline in the 10-year Treasury yield in 2023;
Second, the reason why the central bank pays attention to the 10-year treasury bond yield is not because of the exchange rate impact, but because it is worried that the yield will fall too quickly and affect the bank's net interest margin, thus leading to systemic risk of the bank;
Third, based on the experience of quantitative easing in the United States, the scale of the central bank's buying and selling of government bonds in the open market will only have an impact on yields if it is large enough and sustainable. At present, the People's Bank of China's borrowing and selling of bonds has only a short-term impact and psychological impact on the market;
Fourth, compared with long-term treasury bond yields, short-term treasury bond yields are more affected by central bank policies. It is expected that in the future, with the downward shift of the center of the interest rate corridor and the relative easing of the central bank's monetary policy, short-term bond yields are likely to decline more significantly;
Fifth, the asset shortage has led to a rapid convergence in the yields of government bonds and high-grade bonds, while the yield spread between government bonds and high-risk bonds first widened and then converged. This shows that the worsening asset shortage has led to a passive increase in funds allocated to some high-risk bonds, and it is expected that the relevant credit spreads may converge further.
This article only reflects the author’s views.
