On July 25th, the 30-year government bond yield fell by 3.5 basis points to 2.4150%, reaching a new low since February 2005.

Recently, the central bank has launched a combination of interest rate cuts. On the 25th, the MLF (Medium-term Lending Facility) rate was reduced by 20 basis points, leading to a significant increase in the bond market at the opening, with yields across all maturities falling. The main contracts for 10-year and 30-year government bond futures successively set new historical highs. Towards the end of the trading day, the 30-year government bond yield plummeted, nearly breaking through the 2.4% mark.

"There is still room for future interest rate cuts," said a bond trader at a public fund to the reporter. Following the 10 basis point cuts in OMO (Open Market Operations) and LPR (Loan Prime Rate), the MLF was unexpectedly reduced by 20 basis points on the 25th, and the bond market's desired interest rate points are also expected to follow suit.

Market participants believe that the bond market is oscillating between institutional reactions and the central bank's expectations. The yields on 10-year and 30-year government bonds, at 2.2% and 2.4% respectively, will become new points of contention. However, short-term bonds have been overbought, and opportunities for medium to long-term bonds have increased.

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Long-term bond yields hit new lows

Following the implementation of OMO and LPR rate cuts, the MLF also followed suit with a 20 basis point reduction. State-owned banks have reduced their listed deposit rates. Amid a series of market rate cuts, bond market yields have also shown a significant downward trend.

As of the close on the 25th, the yield on 10-year government bonds fell by 2.8 basis points, touching the 2.2000% level, setting a new historical low; the yield on 30-year government bonds fell even more significantly by 3.5 basis points, approaching 2.4000%. The decline in yields for short-term varieties was more restrained, with the yields on 1-year, 3-year, and 5-year maturities remaining unchanged from the previous trading day. In terms of futures, the main contract for 30-year government bonds rose by 0.41%, quoted at 110.13 yuan, a historical high, while the main contracts for 10-year, 5-year, and 2-year bonds fell by 0.04%, 0.05%, and 0.01% respectively.

"The response must be swift, as interest rates are very likely to fall further. If you are slow, you may not be able to buy suitable current bond varieties," the aforementioned trader told the reporter. Interest rate cuts in the second half of the year may still be on the horizon, and the market is generally concerned that current bond yields are the highest point of future yields, and the game between the market and the central bank continues.

This phenomenon has been reflected in the past few days. Since the beginning of this week, the bond market has been disturbed by the news of interest rate cuts, and the overall yield has fallen amidst fluctuations. On July 22nd, the central bank introduced a "combination punch" of interest rate cuts. On that day, the yields on 10-year and 30-year government bonds fell to 2.243% and 2.483% respectively, breaking through the important thresholds of 2.25% and 2.5%. On the 23rd, the yields on interbank spot bonds fell across the board, with the largest declines in the 3-year, 5-year, and 7-year medium-term varieties, among which the yields on 5-year and 7-year government bonds set new historical lows.

The reason for the "hasty" entry of funds, in the view of industry insiders, is due to concerns that yields in the second half of the year may not meet expectations. A trading person from an insurance institution told the reporter that after the concentrated interest rate cuts, the insurance preset rate of 3%, although "precarious," is still higher than the yield of many financial products on the market. It is expected that more funds will flow in during the second half of the year, and the importance of ensuring the yield of this part of funds is imminent.Overall, the mentality of under-allocation continues to drive the trading behavior of institutions. "July, as the starting point of the second half of the year, often sees a change in the mentality of institutions," Liu Yu, Chief Fixed Income Analyst at Huaxi Securities, believes that the choice of allocation rhythm by institutions and the uncertainty of liability inflows make many institutions still suffer from the pain of under-allocation. For example, small and medium-sized banks that were slow in allocation progress in the first half of the year may still have the need to rush for performance in the second half of the year, while wealth management and insurance may face the pressure of allocating new funds.

"Long-term bonds have quickly dropped to a new level in a short period, and it is not ruled out that trading desks will enter the market in the short term," a fixed income person from a wealth management company in Shanghai told the reporter. Since the beginning of this year, the "asset scarcity" has intensified, and many investment departments have adjusted their investment strategies, turning to trading desks for returns, and policy arbitrage trading strategies have gradually taken the lead.

He also said that the policy arbitrage trading strategy is mainly influenced by the central bank's reduction of the 7-day reverse repo rate, which has led to a decrease in long-term Treasury bond yields. "Many institutions buy long-term Treasury bonds for arbitrage, causing the yield on long-term Treasury bonds to fall again."

"The strength of the market's long-term Treasury bond buying this time is not small," a fixed income person from a fund told the reporter. If the market continues to ignore the central bank's "warning" and still rushes into the long-term bond market to push up yields after the OMO rate and MLF rate have been successively reduced, the central bank may be ready to "sell bonds" soon.

2.4% becomes a key point

The game between the market and the central bank continues, and the long-term bond yield point has become an important signal for rotation.

A trader told the reporter, "Before the interest rate cut, the bottom line of the 10-year Treasury bond yield was around 2.2%, and after the interest rate cut, the central bank's tolerance may increase, and it may fall by about 10bp; the bottom line of the 30-year Treasury bond yield may also fall to around 2.4%."

Zhang Wei, a fixed income analyst at China Merchants Securities, analyzed that before this OMO interest rate cut, the 10-year Treasury bond fluctuated in the range of 2.2% to 2.3%, which is a spread of 40bp to 50bp with the OMO interest rate, far lower than the average spread of 70bp from 2022 to 2023. In addition, in the central bank's latest MLF operation, the interest rate was reduced to 2.3%, but the current one-year interbank certificate of deposit rate center is still hovering around 1.95%, with a spread of 35bp.

This means that the market expects the OMO interest rate reduction space this time to be about 20bp, and the MLF interest rate is still high, and there is still room for the OMO and the closely linked LPR to be reduced in the future.

Ming Ming, the chief economist of CITIC Securities, believes that from a long-term perspective, the downward direction of deposit interest rates, policy interest rates, loan interest rates, etc., is still relatively stable, and the trend of bond interest rate long positions is still there.With the 2.4% yield rate on the verge of breaking, expectations of when the central bank will intervene in the bond market have become a significant factor disturbing institutional trading. A trading officer from a rural commercial bank told the reporter that the central bank's intervention in the bond market is aimed at stabilizing long-term interest rates to prevent them from falling too quickly. Currently, major interest rates in the market are entering a downward channel, and with frequent adjustments, the central bank's tolerance has increased, so the "selling of bonds" in the open market may not come as quickly.

A cautious bank wealth management trader also told the reporter: "Although the rapid decline in long-term bond yields is tempting, the 'selling of bonds' has not yet been implemented, and the bearish factors have not been digested, increasing the risk of taking long positions, so we dare not easily buy bonds."

Ming Ming stated that after the interest rate cut for the Medium-term Lending Facility (MLF) in July, the rates for long-term and ultra-long-term bonds have further declined, approaching their previous low points. It is necessary to be vigilant about the possibility of the central bank preparing actual borrowing and bond-selling operations in the short term, which may lead to a temporary interest rate rebound.