Bond Market: Allocation Behavior Reappears

On January 7 this year, we discussed the possibility of a shift in the bond market (see "Discussion on the Bond Market at the Beginning of the Year"). Looking back, that was a good buying opportunity. Notably, as long-term interest rates rose, allocation activities from banks and insurance institutions have recently reappeared.Does the return of allocation activities indicate that interest rates are near a stage high?

To resolve this question, it's first necessary to understand the reasons behind this round of bond market adjustments.Since March, the rise in long-term interest rates mainly reflects the pricing in of inflation expectations.As the impact of soaring oil prices since the Iran-Israel conflict gradually manifests, there is further room for industrial goods prices to rise. It is expected that the PPI year-on-year will likely turn positive around April or May.

However, from a medium-term perspective, “imported inflation” has yet to drive up consumer goods prices, making it hard for monetary policy to influence the interest rate center.Looking at the household sector, the current data across income, employment, retail, real estate sales, and credit are all neutral to slightly weak, so a supportive monetary policy stance needs to continue. Overall easing is just a matter of time.

Since the direction of monetary policy is unchanged and bond yields remain within a range, the return of allocation behavior is still an important signal.In terms of relative value, the 10-year government bond yield of 1.8%-1.9% is already close to the actual return on loans, so the allocation value has rebounded. Of course, the sustainability of allocation activities under cross-quarter effects remains to be seen, but at least the current long-end prices are somewhat attractive.

In terms of timing, the next wave of fiscal stimulus is worth watching, especially as the issuance of ultra-long special government bonds begins, with fiscal strength possibly peaking around May.For 2025 and 2026, fiscal moves have been somewhat brought forward. Analyzing based on issuance plans and maturity volumes, net government bond financing in Q2 (expected to be 4.2 trillion RMB) is likely to reach an annual high.

Overall, we believe that inflation and fiscal factors will provide medium-term support for a relatively high term spread, but in terms of pace, the bond market is not pessimistic in April.The monetary policy stance remains unchanged, so carry trades in medium-term maturities (such as 5-7Y policy bank bonds) are a good choice.

To summarize today's discussion:

1. As long-term interest rates rise, institutions have recently resumed allocation activities. Since the direction of monetary policy has not changed and bond yields are still oscillating in a range, allocation behavior remains an important signal;

2. We expect year-on-year PPI to possibly turn positive in April-May, and fiscal strength may peak around May. Both these factors structurally support term spreads, with the current 30-10 and 10-5 year spreads at relatively high levels in recent years;

3. In terms of timing, the bond market is not pessimistic in April overall. With the monetary policy stance unchanged, carry trades in medium-term maturities (like 5-7Y policy bank bonds) are a good choice.