The recent surge in the bond market is attributed to various factors; however, one trader remarked that trade behavior is currently dominating the market dynamicsThis observation emphasizes the necessity of scrutinizing the trading risks prevalent in the current environmentAs 2025 began, the bond market continued its upward trajectory, with 10-year government bond yields dipping below 1.6% at one point, and stabilizing at that figure on January 3rdMeanwhile, yields on 30-year government bonds also fell below 1.85%. Market analysts suggest that while the fundamental economic recovery remains to be fully assessed, the impact of a loose monetary policy combined with expectations for interest rate cuts and reserve requirement reductions create a complex backdrop for bond investorsIt is anticipated that the underlying logic supporting this bond market rally may face challenges in completely reversing course, with future interest rates likely hovering at lower levels

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However, traders express caution as multiple disruptive factors loom over the bond marketIt appears that the market has already priced in significant expectations around rate cuts, and shifts in fundamentals, liquidity, governmental debt supply, institutional allocation strategies, and inflows of fresh capital may impact price stability, indicating that fluctuations may become more pronounced in the near term.

During the first week of January 2025, the bond market not only maintained its upward trend but also exhibited significant resilienceOn the first trading day, January 2, both short-term and long-term bond yields generally declined, and on January 3, despite a substantial drop in equities, the bond market continued to flourish, with 10-year government bonds remaining at around 1.6% and 30-year yields dipping rapidly below 1.85%. This downward trend in yields appears relentless

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Notably, concentrated trading activities among institutional investors have played an essential role in this ascent.

Institutions have shown a vigorous trading appetite, notably represented by funds that continue to buy into bonds, extending their duration further.

An analyst from Shanxi Securities, Wang Guanjun, confirmed that the market's current trajectory seems correlated with 'institutional clustering.' The central bank's loose monetary policies have provided ample liquidity to institutional investorsMeanwhile, despite the absence of a reserve requirement ratio cut, the expectation remains that such measures will eventually provide further monetary easingThis duality of current ample liquidity and anticipated future easing continues to galvanize institutional momentum in pursuing bond investments, effectively driving prices higher.

Additionally, the recent downturn of the stock market has reinforced the perceived inverse relationship between stocks and bonds, prompting institutional investors to pivot towards an increased bond allocation to hedge against the downturn risks in equities

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This shift has provided notable buoyancy to bond prices.

Fundamentals, too, have lent robust support to the bond market.

Since September of last year, regulatory bodies have frequently intervened in pricing mechanismsFor instance, the release of the interbank borrowing rate initiative in November aimed to guide down rates on non-bank depositsThe central bank’s significant bond buying action on the last trading day of December 2024 provided additional market confidenceOn that day, the central bank executed a massive 1.4 trillion yuan reverse repurchase operation alongside a net purchase of 300 billion yuan worth of government bonds, complemented by a continuation of 300 billion yuan in medium-term lending facility (MLF) operationsThis hefty infusion of 2 trillion yuan into the banking system helped counterbalance the expiration of 1.45 trillion yuan in MLF contracts scheduled for that month.

While this monetary easing did not constitute a direct reserve requirement cut that the market had been hoping for, its impact on liquidity remained significant

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According to statistics released by the central bank at the end of November 2024, a net injection of 550 billion yuan in base liquidity was analogous to a 25 basis points reserve requirement cutAnalysts like Wang Guanjun would emphasize that such easing policies are a primary motivating force behind the ongoing rise in bond prices.

Continued Loose Liquidity Expected

On January 3, news from the People’s Bank of China indicated that the fourth quarter monetary policy committee meeting for 2024 took place on December 27. The meeting deliberated on key approaches for upcoming monetary policy, recommending an increase in the intensity of monetary policy regulation, as well as improving its foresight, targeting, and effectiveness, while advising the potential for interest rate cuts and reserve requirement reductions depending on domestic and international economic conditions.

When juxtaposed with the previous quarter's statements, this latest meeting had an added emphasis on the flexible potential to apply these measures in reaction to evolving economic scenarios and market performance—suggesting that the environment of loose liquidity is unlikely to change in the short term.

Analysts such as Tan Yiming from Minsheng Securities have pointed out that historically, the likelihood of a reserve requirement cut occurring from December to before the Spring Festival is relatively high

Therefore, expectations lean towards a potential cut of 25 to 50 basis points in January could alleviate issues regarding funding rates while also encouraging downward trends in certificate of deposit rates.

Conversely, in the absence of a reserve requirement cut, the central bank is expected to jointly utilize reverse repos, MLF operations, and bond market interventions, yet continual high funding costs could persist, maintaining a structural reality of ample liquidity but at elevated prices for funds.

Market analysts anticipate a relatively optimistic situation for liquidity leading into the Spring FestivalCurrent expectations do not indicate significant weakening in the economic fundamentals, as local government bond issuance is projected at a manageable scale of approximately 115 billion yuan

Meanwhile, under the backdrop of a stated 'moderately loose monetary policy', it is likely that the central bank will continue to exhibit a supportive stance.

Regarding the measures of easing, predictions by Ping An Securities suggest that although the direct reserve requirement cut remains elusive, there is still a viable chance before the Spring Festival to inject long-term liquidityThe introduction of new tools such as targeted reverse repos and bond market operations adds liquidity but with lesser efficacy than a reserve requirement cut.

Increased Short-term Volatility, Limited Space

Despite the overall positive market outlook, some institutions have begun to adopt a more cautious approach, as mentioned by several bond traders

The consensus within their organizations has leaned towards increased skepticism, acknowledging the limited maneuvering space available in the current marketplace.

According to Yan Ziqi from Huaan Securities, the force behind last week’s bullish momentum mostly came from funds, while other institutional trading strategies expressed more cautionObserving secondary market transactions illustrates that primary purchasing activity stems from funds, indicating a divide in buying strength among other institutions opting for a more reserved stancePreferences seem to pivot towards government bonds, policy financial bonds, local government bonds, and differentiated credit debts.

Given the historical context, this subdued purchasing behavior among insurance companies towards 30-year government bonds suggests a reluctance to extend duration ahead of the past year's performance

Major banks are noted for net purchases of interest rate-sensitive bonds, although the pace at which they stretch their duration has slowed markedly.

Indeed, the aggressive trading by certain institutions has drawn significant regulatory scrutinyRecently, three institutions were penalized by the People’s Bank of China for violating regulations governing the interbank bond market, resulting in warnings and fines exceeding 70 million yuanSuch speculative actions in the bond market that lead to excessive leverage could trigger intervention from regulatory bodies, which may incite dramatic fluctuations in bond prices due to heightened market instability.

Sequentially, several institutions are noting that the prolonged environment of liquidity easing might already be fully integrated into market pricing.

Tan Yiming further noted, “At this juncture, market rates have already pre-empted the policy rates, with current bond market yields reflecting anticipated interest rate cuts of over 30 basis points