In recent developments, the bond market has continued to show robust performance, marked by a significant increase across the board in government bond futures and spot pricesAs of market close, the yield on the 10-year government bond has decreased by 5.15 basis points, settling at 1.6125%. This upward trend in bond prices can be attributed to several factors affecting investor sentiment and expectations about future monetary policy.

Investors are now confronting a complex and uncertain environment as long-term interest rates enter what could be termed a "no man's land." Particularly in the wake of recent signals from the central bank regarding interest rate risks, some investors are left pondering the potential for adjustments in the marketWhat exactly does the current yield of 1.6125% on a 10-year government bond reflect? Is there a risk of a correction in the bond market as we move further into the new year?

In a research report released on December 30, Li Yishuang, the chief fixed income analyst at Cinda Securities, discussed these precise concerns

He pointed out that the yield of around 1.7% on the 10-year government bonds seems "not excessively priced." For the monetary policy to approximate a marginal easing level akin to that expected in 2024, the central bank's open market operations (OMO) rate would likely need to be cut by 50 basis pointsThis insight aligns with the market's evolving practices since July regarding bond pricing.

There have been observations that the yields on 10-year government bonds typically assume a base determined by adding 40 to 50 basis points over the OMO rateTherefore, going forward, a rough benchmark can be established at "OMO rate + 45 basis points." If the current OMO rate is pegged at 1.5%, a potential reduction of 50 basis points could further take the OMO to 1.0%. This would not render the existing pricing of the 10-year bond yield of 1.7% unreasonable.

Turning our attention to the broader economic landscape, the logic behind policymaking seems to be shifting dramatically as we move into the new year

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Cinda Securities' report views 2024 as a year in which the core conflict for the bond market revolves around the starkly contrasting expectations of significant policy loosening versus the reality of gradual incremental movementsSince March, there has been an ongoing signal from the central bank about the rapid decline in market interest rates, even going to the extent of directly selling long-term bonds to anchor market expectationsNevertheless, the trend of declining long-term rates remains intact.

The substantial drop in policy interest rates during Q3 signifies a convergence of market expectations with actual policy adjustmentsThis shift in interest rates reflects an evolution in economic reliance—marking a movement away from a growth model that heavily depended on the real estate sectorPost-September 2024, a noticeable shift in policy logic emerged and was later confirmed in the central economic work conference at the end of the year, suggesting a new realm of monetary thinking.

During this pivotal meeting, the emphasis was placed on expanding domestic demand, marking it as a top priority for 2025's agenda

However, the accompanying call for investment effectiveness suggests that the path to achieve this will diverge from the historical reliance on large-scale investmentsThe focus appears poised to shift towards enhancing residents' consumption capacity to bolster sales within the consumer marketThe government’s articulation of fiscal policy aligns well with existing expectationsHowever, there’s a notable adjustment in the tone of monetary policy, highlighting an acknowledgment from the central authority of the need for further relaxation of monetary policy.

Cinda Securities perceives a pressing need and capacity for China to further relax its monetary policiesThe analysts highlight that, following the recent adjustments to deposit rate ceilings and the regulation of high-interest deposit mobilization, there has been a significant release of potential within the interest rate transmission mechanism

If the marginal loosening of monetary policy in 2025 is to mirror that of 2024, more considerable policy interest rate reductions must follow.

The report underscores that, even though China’s long-term bond yields are only surpassed by Switzerland and Japan among major economies, the current inflation levels in China remain lower than those in such developed marketsAdditionally, the stability of the Renminbi against many emerging market currencies affords the country a unique position to experiment with more expansive monetary policiesThe prior cautious, incremental approach in policy logic seems to have transitioned, and unless inflation decreases significantly in China, continued reductions in policy rates are anticipated.

With this context set, market expectations have started to coalesce around the notion of easing monetary policyIn 2024, numerous bonds have seen yield reductions surpassing 80 basis points, with only the OMO rate and the R007 showing comparatively modest declines

This suggests market anticipation of further OMO rate cuts; conversely, it also reflects that current funding costs have inhibited broader declines in interest rates.

Cinda Securities predicts that should the 10-year government bond yield break through 1.7% by the end of 2024, it will represent a degree of pricing in the anticipated scope for OMO interest rate reductions in 2025. This perspective confirms that a further easing of monetary policy is not just likely but becoming essentialEven if rates do not shift downward post-Year End as optimistically expected, a significant reversal in market sentiment seems unwarranted.

Lastly, as we look towards 2025, growth in the real estate sector is expected to taper, reducing its drag on the economyHowever, sustained expansion in manufacturing and infrastructure investments' support for economic performance is projected to falterMeanwhile, external demand will likely become less favorable, and although consumption might help offset some decline in demand, it probably won’t suffice to propel the economy into a robust growth cycle in the short term.

In such a backdrop, the report suggests that should monetary policy aim for a marginal loosening akin to that observed in 2024, the required cuts in the OMO rate would need to be about 50 basis points