The approach of the Chinese Lunar New Year in 2025 marks a notable shift in the bond marketAfter a strong upward trend earlier in the year, prices have entered a phase of volatility, creating a climate of uncertainty for investors and analystsThis shift in momentum is particularly intriguing, as it comes just weeks before one of the most significant cultural celebrations in China, traditionally a time when financial behaviors can be influenced by seasonal spending and investment typically associated with holiday festivities.

Statistics from Wind (a financial data and analytics service) reveal that, through the early months of 2025, the price of government bonds, which had risen earlier, began to experience a downward adjustmentThe corresponding yields, which typically move inversely to prices, saw a similar trajectory—initial declines were followed by an uptickThe situation at the end of the lunar new year holiday showed yields receding towards levels seen at the end of 2024, wiping out most of the reductions made at the year’s onset.

Reflecting on 2024, it was a year characterized by unprecedented appreciation in government bonds, a phenomenon that many dubbed an "epic bull market." This was largely attributed to a scarcity of safe-haven assets, driving significant investor favor towards long-term government securitiesThroughout this year, yields on various maturity bonds fell dramatically, astonishing many market participants.

A prominent voice in this sector, Zou Lan, the director of the monetary policy department at the People's Bank of China, asserted that those who bought 30-year bonds at the end of 2023 would have realized a nearly 20% return by early 2025. However, as the bond yields hovered around historical lows—1.63% for 10-year bonds and 1.80% for 30-year bonds as of mid-February—such enticing returns seemed increasingly coupled with underlying risks.

Market analysts warn that while long-term bond yields may reflect optimistic expectations regarding future economic growth, they are equally susceptible to fluctuations in supply and demand

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Zou cautioned that should yields fail to accurately mirror economic fundamentals or if significant supply-demand disruptions occur, institutions could face substantial short-term lossesFor instance, a mere 30 basis points increase in the yield of a 30-year bond could lead to a price decline exceeding 5% in the secondary market.

Since April 2024, the central bank has repeatedly cautioned about the dangers of yields falling too lowPan Gongsheng, the governor of the bank, noted the lessons learned from financial risks, such as those epitomized by the collapse of the Silicon Valley Bank in the U.SHe emphasized the importance of monitoring entities, particularly non-banking fiscal institutions, heavily invested in long-term bonds, potentially exposing themselves to mismatches in maturity and interest rate risks.

A multitude of sources indicate that an abundance of liquidity contributed significantly to the dramatic declines in bond yieldsIn early 2024, the People's Bank of China, striving to fortify a rebound in the economy, shifted policy stances to facilitate a generous liquidity environment, moving from "reasonably sufficient" to "sufficient" liquidity measures.

According to bond investment managers, bonds have typically remained tools for managing liquidity, especially when demand for credit falls shortLiu Huan, a bond investment manager, conveyed that during periods of insufficient credit demand, investing in bonds becomes the sole means to prevent capital from being idly underperforming.

Recent trends show the international economic landscape placing additional pressures on the Chinese currency as the U.S. dollar strengthens, leading to depreciation pressures on the yuanWith government bond yields sinking, the interest rate differential between China and the United States has widened, further exacerbating pressures on the yuanAs a precaution, the central bank has begun tightening market liquidity, pushing short-term rates higherFor instance, the DR007—an indicator of liquidity—soared to 2.34%, marking a two-year high.

Looking towards the remainder of 2025, analysts express mixed sentiments about the market's trajectory

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Some maintain that recent market performances have anticipated further rate cuts, meaning the space for continued yield declines may be limitedLiao Zhiming, chief analyst for fixed income at Huayuan Securities, posits that the bond market may have oversold the expectations for monetary policy easingHe highlights that the considerable yield drops observed in past months have effectively exhausted the potential for future rallying in 2025.

As the new year approaches, the notion of "tight money" has become a widespread reality among bond tradersThe liquidity in the interbank market has tightened considerably since January, causing interbank borrowing costs to surgeReports indicate that overnight funding costs for non-banking institutions reached alarming levels—up to 20%—as liquidity pressures mountedWith the CFETS-NEX index showing signs of a strained funding environment, cracks in the market sentiment became apparent.

Various traders noted that around January 15, expectations surged that the central bank would inject liquidity, but when those expectations weren't met, funding defaults occurredConsequently, several institutions began offloading bonds to alleviate liquidity shortagesIt was a classic case of "selling to breathe" in a market that was rapidly tightening, as firms sought to recoup liquidity in the face of skyrocketing borrowing costs.

Investors, including retail ones, also began engaging in government bond reverse repos, which allow for short-term borrowing against bond collateralSuch strategies showcase a push towards exploiting favorable conditions amidst volatilityFor instance, on January 17, one-day reverse repos yielded upwards of 7.77%, representing an exponential increase in returns and prompting financial institutions to ramp up their marketing efforts for such products.

Looking back on 2024 offers insights into why the bond market experienced such a remarkable bull runAs highlighted by Liu Huan, no one anticipated the degree to which bond yields would fall at the year's commencement

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