On February 18th, the A-share market experienced a downturn, and the bond market followed suit with continued adjustmentsGovernment bond futures across the board closed lower, with even long-term bonds—previously holding steady—seeing a rise in yields throughout various maturities in the interbank bond market.

Several fixed-income researchers noted that despite the long-term expectations of increased monetary supply remaining intact and no substantial change in the asset shortage scenario, the tug-of-war between bulls and bears in the bond market has intensifiedIt is expected that prior to any reduction in the reserve requirements, the liquidity situation will remain tight, causing yields to shift upward along the curve.

Recently, the Ministry of Finance announced support operations for government bonds on February 18, specifically targeting bond maturities for 2025, with a selling orientation involving a total of 890 million yuan in 2- and 3-year notesMarket participants view this move as a routine operation by the Ministry, aimed at adjusting the supply-demand relationship for ultimate bonds and enhancing liquidity in the secondary bond market, though its impact is anticipated to be localized, with broader market trends still hinging on liquidity conditions.

Intensifying Competition in the Bond Market Amidst Liquidity Crunch

On February 18, government bond futures showed weakness at open, recovering slightly in the afternoon but still finishing lower across the board

Advertisements

By the end of trading, the principal contract for 30-year bonds had dropped by 0.32%, the 10-year principal contract fell by 0.17%, the 5-year contract decreased by 0.07%, and the 2-year contract was down by 0.04%. Notably, the 30-year principal contract has lost 2% over the three trading days since the previous Friday.

In terms of cash bond trading, yields on various maturities in the interbank market mostly increased, with 1-year and 5-year actively traded bond yields rising by 4 and 1 basis points respectivelyThe popular 10-year bond "24 Accrued Bond 11" saw fierce buy-sell activity throughout the day, ultimately closing flat at 1.67%, while the 30-year "24 Special Treasury Bond 06" also fell back towards the end, wrapping up at 1.882%, down by 0.8 basis points.

On February 17, the Ministry of Finance released guidelines regarding the support operations for government bonds in February 2025, disclosing the amounts of 520 million yuan for the 2-year bond and 370 million yuan for the 3-year bond, to be executed via a competitive bidding process on the morning of the following day.

According to bond analysts at various brokerages, the Ministry's operations are part of a regular mechanism, assessed in light of market supply and demand, as well as the central bank's liquidity management strategiesHowever, they emphasized that the current situation with banks indicates a significant liquidity crunch, which could make the market more sensitive to such newsDespite this, the operations mainly focus on regulating localized supply-demand conditions for specific bonds and generally involve relatively small amounts, suggesting limited overall impact on the bond market in the short term.

Back in September 2016, in a bid to bolster market liquidity for government bonds and enhance the reliability of the government bond yield curve, the Ministry of Finance, along with the central bank, announced the establishment of a government bond support mechanism

Advertisements

This means that the Ministry employs buy and sell tools in the interbank bond market to support market makers in their activities involving recently issued key maturity government bonds.

During times when a certain key maturity bond sees weak interest in the secondary market, leading to a clear oversupply scenario, the Ministry will buy back the bonds from market makers—this is referred to as a buy operationConversely, if demand exceeds supply in the secondary market for a specific key maturity bond, the Ministry will sell a portion of the bonds to market makers to ensure liquidity, known as a sell operationOfficials from both the Ministry of Finance and the Central Bank's financial market department clarified this mechanism in response to press inquiries.

According to the operational procedures for the government bond support mechanism, the volume for such operations reflects comprehensive assessments of expectations regarding central treasury fund predictions, liquidity within the banking sector, and demands within the government bond market, decisions jointly made by the Ministry of Finance and the central bankThe initial plan allows for no more than once a month for government bond market support operations, generally scheduled for the third Tuesday of each month; during buy operations, the scale is maximally 2 billion yuan, and the sell operations can be as high as 3 billion yuan each time.

Looking back at previous months, actions taken by the Ministry for the support of government bonds were primarily focused on sell operations, and the types of securities involved, along with the operational volumes, varied based on the prevailing market conditions.

Since the start of 2024, all of the Ministry's operations have favored sell actions, mainly involving 2-year, 3-year, and 5-year bonds

Advertisements

Notably, operations during April to July and in December saw higher volumes of 2.98 billion, 2.46 billion, 1.89 billion, and 2.49 billion respectively, with the exception of July where ten-year bonds were the focus in the two operations; the others primarily concentrated on shorter to medium-term issuesIn January of this year, the ministry's sell operation involved 10-year and 2-year bonds totaling 770 million yuan.

Since last year, fueled by multiple elements such as a slowly recovering macro economy, a loose monetary environment, and an asset scarcity scenario, China's bond market has enjoyed a bull runHowever, just after the year-end, liquidity did not ease as the market had expected, leading to a retreat in the short-term bond marketAlthough long-term bond rates have remained relatively firm, the outlook has fragmented as institutions foresee that liquidity conditions will likely stay tight in the short term.

Last Friday, newly issued 1-year and 50-year government bonds saw rates soar, exacerbating concerns over banks facing liquidity shortages in the interbank market.

Focus on the Timing of Reserve Requirement Cuts

What impact do government bond market support operations have on the management of liquidity within the banking system? According to Qiu Yuanhang, an analyst within the FICC department at CITIC Securities, the influence of the Ministry's bond market support operations is more localized rather than overarching

The forthcoming movements are largely dependent on the Central Bank's actions.

"Generally speaking, government bond market support operations are considered when the secondary market can no longer adequately satisfy market-making requirements, or when any key maturity bonds exhibit poor liquidity in the secondary market," asserted the aforementioned officials from both the Ministry of Finance and the Central BankEstablishing such support mechanisms has been a common practice amongst major developed nations that aim to foster healthy growth in their government bond markets, often serving as a means to "fill gaps" in market function, where the operational scale typically remains modest and secondary market operations adequately consider predictions related to central treasury funds and liquidity in the banking sector, thus minimizing significant impacts on bank-level liquidity.

On February 18, the central bank conducted a 4.892 billion yuan, 7-day reverse repurchase operation; taking into account the 330 million yuan reverse repos and 5 billion yuan in MLF that matured that day, the net withdrawal amounted to 438 million yuanIn the first two weeks following the conclusion of the Spring Festival holidays, the central bank's actions netted a total of 10.213 billion yuan in funds returned during the first week and 4.709 billion yuan in the second week.

CITIC Securities' chief economist, Ming Ming, remarked that despite a slight tightening of liquidity sentiment post-holiday and the pressure that commercial banks face on liabilities, the central bank persists in its withdrawals, signaling a continued practice of offering loose policies in statements while executing stable actions.

As tax periods draw nearer and local bond issuance increases, market operators are closely monitoring the central bank's forthcoming public market actions

Advertisements

Advertisements