On February 25th, a significant adjustment in the bond market occurred due to multiple factors, including a tense liquidity situation that put immense pressure on the marketThe yield on the 10-year government bonds demonstrated a lack of effective breakthrough around the 1.6% level since the beginning of 2025. Following the Spring Festival, these yields soared, resembling a runaway horse as they rose steadilyBy the close on February 24th, the 10-year yield surged from a low of 1.606% on February 7th to a temporary high of 1.7577%. This represented an increase of over 15 basis points within just 12 working days, reminiscent of the significant adjustments seen during last year's pivotal "924 meeting". Despite this upheaval, today saw a bounce back in the bond market, injecting a dose of optimism into an otherwise anxious atmosphereBy mid-afternoon, the yields on key interbank government rates fluctuated significantly, with the 10-year government bond active instrument yielding 1.72%, and the 30-year bond yielding 1.9125%. Meanwhile, the yields on 10-year China Development Bank bonds were pegged at 1.74%.

Nonetheless, the market remains fraught with uncertainty and concerns; is the current adjustment merely a warning or a "halftime break"? Are the risks of redemption within the bond market manageable? How should investors maneuver in this precarious post-adjustment environment?

The recent extensive adjustment in the bond market has left many bullish primary market players with considerable "psychological shadows." Examining the market dynamics, the main T bond futures contract experienced a sharp decline shortly after the Spring Festival, effectively erasing the gains achieved this year in just ten daysThe yield on 10-year government bonds skyrocketed more than 15 basis points, reaching just under the 1.8% markThe certificate of deposit market has adopted a "fire sale" mentality, with AAA-rated one-year deposits surging past the 2% markAmid tight short-term liquidity conditions, the inversion of interest rate spreads in various instruments like certificates of deposit and credit bonds has become a typical reflection of the adjustment witnessed in the post-holiday bond market.

Some industry insiders now argue that this dramatic adjustment may stem from a convergence of technical corrections as well as responses to policies, funding conditions, market sentiment, and institutional behaviors

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A trader from a certain brokerage pointed out that the recent surge in pre-redeem pressure in the bond market primarily arose from the failure of anticipated cuts to reserve requirements and interest ratesThis trader believes the rapid acceleration in bond pricing began with the central bank's decision on December 9th last year to pursue a moderately loose monetary policy, which sparked premature betting on interest rate cutsDuring that time, the spreads between 10-year government bonds and the 7-day Open Market Operation rates compressed by about 20 basis points as the market adjusted for the anticipated cutsHowever, the overall funding environment remained favorable, with the 10-year yield decreasing by over 30 basis points throughout December, effectively precluding expectations of further significant downward movement.

Moreover, today’s announcement from the central bank regarding the MLF (Medium-term Lending Facility) being reduced also dampened any lingering illusions of an imminent rate cutWith the MLF maturity volume set at 500 billion yuan this month and only 300 billion yuan rolled over, this aspect correlates with market fears regarding monetary stimuliThe local government’s issuance of special bonds has also accelerated, mimicking a fast-forward motion, and thereby amplifying the sentiment that "the bond market's adjustment resembles navigating rapids."

From a funding perspective, with financial resources gradually reverting post-New Year, liquidity not only remained tight but also led to a pondering exercise of "where did the money go?" This was evident when, last Friday, the R001 rate climbed to 2.15%, exceeding pre-Spring Festival levels by 50 basis pointsAdditionally, the one-year IRS surpassed 1.7%, while the DR007 shot up to around 2.4%. This pattern indicated that for over ten consecutive trading days, rates had exceeded the upper limits of policy rates, and demand from large banks remained lowEspecially with looming tax periods, an influx of government debt, and MLF expirations adding further pressure to liquidity, the central bank’s marginal interventions to absorb excess liquidity maintained this prevalent tightness

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This unwillingness to lend and increasing inability of banks to secure liabilities further illustrated the banking sector's struggles.

Xu Liang, chief analyst for fixed income at Huafu, posits that the sustained tightness in the funding market has dual underpinnings: while pressure on exchange rates has eased, it has not entirely dissipated, keeping the central bank’s commitment to stability higherFurthermore, an initial overpricing of accommodative expectations in the bond market and insufficient effectiveness of the central bank's attempts to manage long-term bond yields have compounded the current financial landscape.

Conversely, many institutions underscore despite the funding tightness being a result of the central bank's current management, expectations of a renewed commitment to ensuring liquidity remain potentAccording to Wang Qing, chief macro analyst at Dongfang Jincheng, although the central bank recently halted second-market government bond purchases, it plans to inject liquidity through significant reverse repos and incremental MLF renewals to uphold plentiful mid-term market liquidityThis strategy aims to bolster banks' credit allocation and stabilize market expectations regarding government bond issuance.

Alarm bells regarding redemption risks in the bond market are growing louderThe uniform expectations among institutions significantly contribute to the feedback effects observed in the bond marketPrompted by the pronounced adjustment, many institutions are issuing warnings to guard against potential redemption pressures within the bond marketsAn investment manager from a brokerage mentioned the shift last year where funds and insurers heavily bet on long-term bonds in expectation of rate cuts by the central bankHowever, as the anticipation for cuts and reserve reductions shifted later than expected, coupled with capital gains dwindling under the tighter liquidity conditions, urgency around holding bonds at historically low coupon rates has changed

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The prospect of a significant peak in special treasury bond issuances may further compel bank-operated trading forces to engage in substantial net selling, heightening potential disruptions within the market.

"Currently, some institutions, especially banks, which have relied heavily on capital gains, have begun to show signs of disbandingOnce a singular path of agreements starts to fray, it’s challenging for others to maintain resilience," noted the investment manager.

Apart from banks, non-banking buyers, particularly funds, are likewise experiencing continuous outflows, adding volatility to the current bond marketEvidence from statistical data by Huafu's analyst Yan Ziqi revealed that from mid-February, funds recorded six consecutive days of net selling, totaling approximately 19.53 billion yuan — although considerably less than the average of prior episodes which stood at 74.73 billion yuanPresently, signs of pronounced redemption pressures within the bond market are not conspicuous.

Nonetheless, Yan emphasized that, considering the previous market performances prior to the holiday, the persistent duration of this adjustment in the bond market has now extended into multiple weeksEntities like institutions managing finances may now have begun modest redemption effortsIn the short term, these actions might not elicit stark reactions within the market, but over the long haul, such gradual adjustments could infiltrate market sentimentShould liquidity not bounce back swiftly, sensitivity to policy and newly introduced information may grow, further elevating volatility in the bond market.

For banking and financial institutions, recent analyses suggest following multiple instances of the breaking net value in bank-managed financial products, improvements in investor education have occurredInvestors now understand that while fixed-income asset management products may fluctuate in value in the short term post net valuation, they yield positive returns over the long haul

Thus, for investors in bank wealth management products, holding onto their investments might be more advantageous than engaging in the costly cycle of pre-emptive redemptions.

In a market characterized by intense competition and increasing sophistication, the balancing act of sharp acquisition amid prevailing volatility has become the focus of ongoing debates among market influencersMany market participants believe that the current environment leans toward a complex interplay of opposing forces within the bond market, suggesting that it may soon undergo its "Schrödinger mode." On one hand, sporadic liquidity lapses could create uncertainty for shorts, while the persistent fear of an asset scarcity lingers on the other.

As for the future trajectory of interest rate bonds, several traders express that employing a "guerrilla tactic" of alternating both defense and offense seems again desirable: “Knowing when to raise the white flag, while ensuring an appropriate distance from bond yields is vitalIt's critical to effectively navigate market positions while fortifying returns on safe assets.”

In the context of credit bonds, Yan Ziqi maintains that short-duration credit bonds exhibit sufficient yield spread protectionConsidering the shape of the yield curve and existing market sentiments, further hikes in short-end yields are improbable, affirming that acquiring short-end credit bonds during adjustments remains a viable strategyUltimately, the bond market is expected to revert to its fundamental pricing mechanisms; however, fluctuations within liquidity contexts will keep dominating short-term impactsHence, the pendulum of pricing power will depend on institutions’ interactions with policy considerations moving forward.

Qi Sheng, chief fixed-income expert at Dongfang, adds that for institutions with stable liabilities, the ongoing adjustment in the bond market, largely propelled by the divergence in liquidity expectations against institutional responses, does not reflect any unexpected fundamental shifts

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