Against the background of long-term decline in interest rates, the central bank intervened during trading on Monday and announced that it will conduct "national bond borrowing operations."

National bond futures fell in response, with the 30-year bond futures closing down 1.1%, previously up more than 0.39% and hitting a historic high. Recently, 30-year national bonds have again begun testing the annual low of 2.4%.

In fact, the central bank's move was not unexpected. Since April, the central bank has publicly addressed long-term bond rates more than ten times, and the Lujiazui Forum also indicated that tools for buying and selling national debt would be launched.

So how should this operation be understood? From the perspective of trading volume, how much national debt is available for the central bank to borrow? From a historical perspective, what experience is worth referencing?

More importantly, what impact will it have on the bond market? Will it be the end of this round of bond bull market? What does it mean for bond funds?

What details are worth noting?

From a timing perspective, Ming Sheng Macro Tao Chuan pointed out that the central bank uncommonly announced the "national bond borrowing operation" during trading hours, making people reminiscent of the last time it stabilized the exchange rate during trading (the foreign exchange self-discipline mechanism conference was held at noon on September 11th last year and financial data was released).

Tianfeng Fixed Income pointed out that first of all, the central bank issued an operation notice on July 1st, possibly purposely avoiding this important point in time at the end of June. If the timing of the announcement is in mid-to-late June, the impact on the bond market may be different. Secondly, the central bank has not significantly increased the liquidity withdrawal for the time being, which indicates that it may still have some care for the market.

In terms of content, Huatai Securities pointed out that this announcement was released on the central bank's official website as "Announcement No. 2 of ［2024］Open Market Operations", and the previous column only published a list of first-tier dealers. This means that national bond borrowing is a new tool that is different from previous repo and bill swap models.

What to do after borrowing? It is highly likely to be sold.

Huatai Securities pointed out that the central bank has been very clear that it is for "maintaining the stable operation of the bond market", so it is highly likely to be sold. Specifically, it can be seen that:

Analogous to bond lending, the central bank should sell current bonds through borrowing, buy back bonds in the future to repay, and interest during the period goes to the lending party. It is equivalent to short-term increase in secondary market supply and increase in secondary market demand in the future, but actually depends on the borrowing period and the central bank's operation after maturity.

Everbright Securities also believes that the main purpose of the central bank borrowing national bonds this time is to sell them at a later time, release monetary policy signals, promote the balance of supply and demand of long-term interest rates, and guide the upward trend of long-term national bond yields. Everbright Securities pointed out:

Some investors believe that the central bank will eventually have to repay the bonds it borrows, so the central bank will buy them back in the market, and the bond buying operation will push yields down again. We think this is indeed the case, but it is a matter for the future and not a key factor affecting the current market trend. Moreover, the timing of buying bonds is controlled by the central bank, which will probably choose to buy them when the yields are too high.

How many national bonds can the central bank borrow? What historical experience is worth referencing?

Secondly, trading volume is key.

Huatai Securities pointed out:

At present, the daily secondary market turnover of national bonds is between 400-500 billion yuan, so if the central bank wants to have an impact on interest rates through selling, the scale of the operation cannot be too small. Even if it is less than 100 billion yuan, it still needs several billion yuan. If it is less than 100 billion yuan, then the expected guiding significance is greater than the actual effect.

According to the custody data disclosed by ChinaBond, as of May 2024, commercial banks held 20 trillion yuan of national bonds, primarily large banks. Roughly estimated, after deducting pledge requirements, first-tier dealers can make roughly 8 trillion yuan of national bonds available for lending. But these national bonds generally do not have long maturities.

From a historical perspective, Ming Sheng Macro pointed out that the newly proposed "national bond borrowing operation" is not mainstream in history. The central bank theoretically has two ways to sell national bonds in the open market: through repo and bond sales, both of which were more common between 2000 and 2014. The central bank’s "national bond borrowing operation" mentioned this time is different from the above two models. We believe that there may be two mechanisms worth referring to.

There are two scenarios for the Bank of Japan's YCC policy: the lower bound scenario and the upper bound scenario. In the lower bound scenario, when the long-term bond yield hits the interest rate lower limit, the central bank can sell a large amount of government bonds, influence the supply and demand relationship of the secondary bond market, and push up interest rates. However, under the background of Japan's long-term ultra-loose monetary policy, there are not many cases of the Bank of Japan selling government bonds after triggering the YCC lower bound.

There are two scenarios for the Bank of Japan's YCC policy: the lower bound scenario and the upper bound scenario. In the lower bound scenario, when the long-term bond yield hits the interest rate lower limit, the central bank can sell a large amount of government bonds, influence the supply and demand relationship of the secondary bond market, and push up interest rates. However, under the background of Japan's long-term ultra-loose monetary policy, there are not many cases of the Bank of Japan selling government bonds after triggering the YCC lower bound.

Does the signal mean more than its actual substance?

Minsen Macro pointed out that, in this case, the signal's significance may exceed the actual substance:

Taking Japan as an example, the central bank needs to buy and sell government bonds on a considerable scale to regulate the market interest rates. At the end of 2023, the Bank of Japan accounted for 48% of the government bond holders, while the People's Bank of China accounted for only 5%. Therefore, the impact of selling government bonds on the market supply and demand is limited. We believe that the central bank is unlikely to follow the path of Japanese-style deficit expansion and massive bond purchases in the future, but is more likely to approach the intervention-styled stable exchange rate operation that has been done before. Therefore, the signal intent of correcting the market error is more significant.

Historical experience tells us that if the market's reaction to expected guidance is too weak, the central bank is more likely to increase the force of expected guidance and begin to use other policy tools, ultimately achieving the coordination of central bank policy implementation and external communication and maintaining the consistency of expectation guidance.

Guotai Junan Securities believes that, compared with the operation scale, the regulator's attitude is more critical.

The scale of borrowing government bonds in a single operation is limited, and even if they are all sold, the impact on the market is limited. We need to reiterate the fundamental viewpoint that the regulator's attitude is more important than the specific tools used.

In addition, the central bank did not explicitly state that it would only carry out a single borrowing of government bonds. If the trend of the bond market in the future does not satisfy the monetary authority, it is reasonable to carry out borrowing and selling of government bonds again and use other policy tools.

What impact will it have on the bond market? Will it become the end of this round of bond bull?

Huatai Securities pointed out:

Periodic adjustments are inevitable. First, the central bank's borrowing of government bonds shows its determination to regulate long-term interest rates, and periodic adjustments are inevitable, and the interest rate bottom is temporarily clear.

But for bond, the logic of long-term interest rate decline has not fundamentally changed. The central bank obviously needs to control the risk of too rapid decline in interest rates and stabilize the China-US interest rate difference.

This is similar to the view of Sun Binbin's team at Tianfeng fixed income:

We judge that we are still in the macro logic of stabilizing growth and loose currency. Therefore, there is no simple reversal in the bond market, and the possibility of interest rate cuts still exists. The overall trend of interest rate decline has not changed. Therefore, comprehensive defense is not yet necessary.

However, in consideration of the short-term perspective, the bond market may still be inclined to range oscillation, with a top and a bottom on the interest rate. As the central bank's actions still need to be observed further, we do not consider adjustment or purchase for the time being.

Huatai Securities further pointed out:

The bond bull in 2016 ended with the deleveraging of finance. The previous phase was the warming of fundamentals (real estate + external demand). The initial intention of the central bank's borrowing of bonds and selling of bonds this round is not to strike at financial leverage, but more to "cool" the bond market. The central bank's original intention is not to let the long-term rate undergo an exceptional adjustment because once it triggers a feedback cycle or affects the issuance of government bonds, it will not be 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. Looking at the cross-quarter put in June, the central bank does not want to trigger short-term fund volatility, and the short-term interest rate is generally stable. The long-term is likely to be the key to regulation. If long-term bonds are sold in the future, the curve shape will tend to be steepened.

Overall, the 30-year treasury bond has not yet broken away from the fluctuation range predicted earlier of 2.4%-2.6%, and the odds of nearing the lower limit have decreased, and we need to pay attention to the central bank's dynamics. Obvious adjustments are still opportunities. After all, the fundamental logic (financing demand, real estate, production demand is strong) has not changed for a lot of long-term under-funding, and as long as the position is high enough, the middle-term fluctuations are only short-term disturbances.

What is the impact on bond assets?

Guangda Securities reminds investors to pay attention to price fluctuations in bond assets:

The upward trend in income in the fourth quarter of 2022 caused a decline in net asset values of wealth management products, such as bank wealth management and public funds, which invest in bonds. The decline in net asset value was accompanied by a reduction in the number of fund shares. At the end of the fourth quarter of 2022, the share of short-term pure bond funds, medium-to-long-term pure bond funds, hybrid bond type level 1 funds, and hybrid bond type level 2 funds decreased by 35.2%, 5.7%, 15.8%, and 9.7%, respectively, compared to the end of the third quarter of that year.

Moreover, there was a mutual reinforcement effect between the decline of net asset value and the reduction of fund shares of wealth management products during that period. Although the current bond market is not exactly the same as before the adjustment in the fourth quarter of 2022, there are many similarities. In fact, there are many bearish factors at present, but they are deliberately or unintentionally ignored by investors. At this time, investors need to take early precautions against price fluctuations in bond assets in order to safeguard their "money bags".

This article is excerpted from Huatai Fixed Income's "Central Bank National Debt Borrowing Operations: New Tools and Policy Bottom", Minsheng Macro Taochuan's "The Thunder in Central Bank Borrowing", Everbright Securities Fixed Income Research "How to Understand the Central Bank's National Debt Borrowing?" and TF Securities Fixed Income Sun Binbin Team "Central Bank Borrowing National Debt, Will the Bond Market Turn to Defense?"