This year, a substantial influx of capital has continuously entered the bond market, fueling a bull market in bonds. However, as long-term government bond yields continue to hit historical lows, the market has started to worry about the risks behind the bull market in bonds.

In recent times, the central bank has repeatedly sounded the alarm, "with a heavy heart," to warn of market risks. At the same time, the "small essays" in the bond market have also been widely circulated. The market sentiment is quite sensitive, intertwined with concerns about under-allocation and increased regulatory scrutiny. The tug-of-war between bulls and bears in the bond market continues, and there are many speculations and questions in the market.

Is it true that some small and medium-sized banks have been "notified to prohibit government bond trading"? Where exactly is the central bank's desired range for long-term interest rates? How did the four rural commercial banks that were reported use borrowed accounts to transfer benefits? How is the progress of the central bank's stress tests on the risk exposure of financial institutions holding bond assets? Has the bond market adjusted properly, and what will the subsequent trend be?

In response to the above hot issues, Yicai recently interviewed authoritative experts in the industry and insiders to sort out the content as follows.

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1. Is the rumor that several banks have been "notified to prohibit government bond trading" true?

Financial regulatory authorities have not prohibited small and medium-sized financial institutions from trading government bonds.

Yicai learned from informed sources that against the backdrop of the tug-of-war between bulls and bears in the bond market, some views deliberately stigmatize financial regulatory authorities as administrative interventionists, and the "prohibition of government bond trading by small and medium-sized financial institutions" is a misinterpretation of the market's response to the financial regulatory authorities' risk warnings. Financial regulatory authorities will definitely adhere to marketization and will not replace market entities; financial institutions have the right and freedom to make independent investment decisions.

There is a market misinterpretation that the central bank wants to control and determine the level of government bond market interest rates.

In this regard, Yicai's reporter recently interviewed Xu Zhong, the deputy secretary-general of the National Association of Financial Market Institutional Investors in China. He said that after the central bank's risk warning, some financial institutions have gone from one extreme to another, "cutting off" government bond trading, which is not only a manifestation of their weak risk management capabilities but also a misinterpretation of the central bank's intentions.

Recently, behind the decline in long-term government bond yields in our country, there are both issues of short-term supply and demand imbalance in the bond market, as well as financial institutions being led by some "small essays," and some financial institutions' insufficient interest rate risk management capabilities.Additionally, there are issues where some financial institutions profit by manipulating market prices and other illegal and non-compliant activities. The next step is for financial regulatory authorities to further improve the monitoring and analysis system for the smooth operation of the bond market, closely monitor, and promptly punish violations, supporting participants to engage in transactions in a normal and compliant manner.

2. Where exactly is the desirable range for long-term bond interest rates?

The central bank has not set a range for long-term government bond interest rates.

There is a market view that the central bank should control and determine the level of interest rates in the government bond market. In fact, this is also a misinterpretation.

Xu Zhong stated that the central bank's risk warnings on long-term government bond interest rates are to curb the systemic risks that may be hidden by the herd effect leading to a one-sided downward trend in long-term government bond interest rates, and it has not set a range for long-term government bond interest rates. This is different from some countries implementing unconventional monetary policies to control the yield curve of government bonds.

After the tug-of-war between bulls and bears, the market's focus remains on the central bank's attention to long-end interest rate levels. This year, the one-sided downward trend in long-term bond interest rates is due to the imbalance of supply and demand in the bond market, with government bond issuance lagging, leading to a one-sided downward expectation. As government bond issuance accelerates within the year and supply increases, it is very likely that expectations will reverse, interest rates will rise, and risks will be triggered. The desirable range for long-term bond interest rates is a dynamic balancing process, and after risk clearance on the basis of market regulation, prices will naturally fall within the desirable range.

In addition, short-term economic indicators generally have a greater impact on government bond interest rates within 2 years, or at most within 5 years. The relationship between ultra-long-term government bond interest rates and short-term economic indicators is not as significant, and they are more influenced by factors such as financial market investment strategies and investment sentiment, making them difficult to predict accurately.

The central bank mentioned in the second quarter monetary policy report "strengthening market expectation guidance, and paying attention to the changes in long-term bond yields during the economic recovery process," which also implies that long-term bond yields should be in line with the fundamentals in the long term.

3. Recently, four rural commercial banks were named for allegedly manipulating market prices and transferring interests in the secondary government bond market. Do small and medium-sized financial institutions have any backroom operations?

Some investors transfer interests through an ant-moving manner, with small amounts and high frequency.A journalist has learned from informed sources that the liquidity in the government bond market is quite active, with very small spreads, but from a long-term perspective, some institutions always trade with a very fixed counterparty. At the same time, asset management institutions have diverted the revenue streams that originally belonged to financial institutions to another account, with traders and some institutional shareholders engaging in interest transfer. Both parties in the transaction have internal control issues.

Xu Zhong stated that some small and medium-sized financial institutions lack sensitivity to interest rate risks. Some small and medium-sized banks have not fully considered the interest rate fluctuation risks of government bond investments. Under a strong speculative atmosphere, some institutions have transformed from a configuration plate to an active trading plate, even treating bonds as stocks for speculation; the concentration of investment is very high, and the bond income of some small and medium-sized financial institutions accounts for more than 50% of their operating income, which to some extent also reflects the imperfect corporate governance and weak risk control capabilities of these institutions.

At the same time, some financial institutions profit from illegal and irregular activities such as manipulating market prices. Some small and medium-sized financial institutions have illegally lent accounts to private equity funds and other institutions, going long on long-term government bonds and shorting government bond futures, manipulating prices, and conducting interest transfers; they have also exacerbated the downward trend in long-term government bond interest rates.

It is understood that from the self-discipline investigation of the violation of trading cases by the trading association, some small and medium-sized financial institutions' management is not familiar with financial market business, has loose internal control, and the incentive mechanism is overly flexible, providing opportunities for practitioners to engage in illegal operations. Some traders have taken the opportunity to collude with private equity inside and outside the market for interest transfer. In addition, high-frequency hedging strategies are common operations of overseas hedge funds, with high investment risks, but domestic small and medium-sized financial institutions are using the deposits of the people to bet on direction and arbitrage price differences. Data shows that the bond income of some small and medium-sized financial institutions accounts for more than 30% of their operating income, and some even exceed 50%. Such aggressive trading strategies obviously exceed their risk management capabilities.

In fact, since last year, the trading association has been concerned about some financial institutions using government bonds for interest transfer. Currently, the trading association has established an enforcement connection mechanism with the securities regulatory authority and public security and other related institutions, and has transferred clues of suspected large-scale interest transfer cases of relevant asset management products to the public security department.

4. Has the central bank started stress testing the risk exposure of financial institutions holding bond assets, and what is the progress?

First Financial has learned that the central bank has started stress testing the risk exposure of financial institutions holding bond assets. The main content of the stress test includes the proportion of financial institutions' bond investments in the balance sheet, bond duration, and whether capital can cover risks. The purpose is to identify the interest rate risk of financial institutions and to propose some risk control suggestions for institutions that hold a large amount of bonds and have a large risk exposure in the short term.

Previously, the central bank has repeatedly warned of bond market risks in the latest monetary policy implementation report, and has stated that it will conduct stress tests on the risk exposure of financial institutions holding bond assets to prevent interest rate risks.

5. How much impact does the expectation of future economic conditions have on the downward trend of long-term government bond yields?

The current economic foundation determines that long-term government bond yields will not continue to decline for a long time.Looking back at the Japanese economy, from the 1970s to the 1980s, Japan's economy rapidly rose, marking a golden era for its economic development. In 1995, the Japanese economy reached its peak. At that time, Japan's total economic output was $5.45 trillion, while the United States was $7.64 trillion, with Japan's economy accounting for 70% of the U.S. total; Japan's per capita GDP was approximately $43,400, which was 1.5 times that of the United States ($28,700). After the 1990s, Japan experienced 30 years of low-temperature economy, and by 2023, Japan's total economic output was equivalent to 15% of that of the United States, with per capita GDP being 0.4 times that of the United States.

Industry experts believe that the trend changes reflected in the above data do not exist in China. China's inflation will not remain below 1% for a long period like Japan's. China's economic development potential is enormous, and there is still a significant room for industrial division compared to the United States, Japan, and Europe. There is also a considerable space for improvement in the quality of the labor force.

Such an economic foundation implies that long-term government bond yields will not continue to decline over the long term. In the view of industry experts, the determinants of short-term and ultra-long-term bond yields are different; the short term is more influenced by short-term economic indicators, while the long term is more affected by sentiment and expectations.

The Third Plenary Session of the 20th Central Committee has clarified the direction of reform in aspects such as improving the fiscal relationship between the central and local governments, focusing on boosting consumption to expand domestic demand, and enhancing the consistency of macroeconomic policy orientation. This includes increasing local government financial resources, promoting the matching of financial power and responsibilities, and giving equal importance to investment and consumption. The country is also accelerating the comprehensive green transformation of economic and social development and deploying a market-oriented and rule-of-law-based mechanism for the orderly exit of inefficient production capacity, emphasizing the unwavering completion of the annual economic and social development goals and tasks.

Xu Zhong believes that as various policy deployments are effectively implemented, the foundation for economic recovery and reform development will be further consolidated, and social expectations will also be further improved.

6. Is the central bank overly concerned about the bond market?

Recently, there has been a proliferation of market rumors, and the high volatility of the government bond market has attracted the high attention of investors. Industry experts emphasize that, first of all, the central bank has a coordinated regulatory system for the bond market. The central bank has only provided risk warnings to institutions with aggressive trading, not all rural financial institutions are at high risk in government bond trading.

The aforementioned experts further pointed out that small and medium-sized institutions do not have a sufficient understanding of interest rate risks in the financial market and are easily swayed by rumors. Recently, as bond market volatility has intensified, the net value of fixed-income wealth management products has also experienced significant fluctuations. The wave of redemptions in the bond market in 2022 has left a deep impression on the market. The level of interest rate risk management of many financial institutions is concerning.

7. After the bond market volatility, what will the subsequent trend be?

The long-term government bond yield is unpredictable.Since 2024, on one hand, the acceleration of local debt issuance is not urgent, and on the other hand, influenced by the progress of debt resolution efforts, the pace of new local debt issuance is significantly lower than the average level of previous years. In the first half of this year, the cumulative net financing of government bonds reached 3.43 trillion yuan, accounting for 37.71% of the annual issuance plan, which is lower than the financing progress of 43.36% in the same period of 2023.

Industry experts analyze that currently, the market's blind pursuit is betting on "less". In the second half of the year, once the issuance of government bonds accelerates, the market will reverse. This is also the reason why the central bank has been continuously making statements to guide and warn of risks in recent times.

Xu Zhong believes that from the perspective of supply and demand, China is currently in an economic transformation period with insufficient effective credit demand. In the short term, a large amount of funds have flooded into the bond market through wealth management and funds, causing excessive trading of government bonds due to strong demand. At the same time, the supply of interest-bearing bonds, including government bonds, was insufficient in the first half of the year, leading to a short-term imbalance in supply and demand. As the supply of government bonds and other interest-bearing bonds increases in the second half of the year, the supply and demand relationship will also change.