Long-end bond yields surged, with loose liquidity and long-end adjustments coexisting; institutions recommend flexible duration management for portfolios

Why do loose liquidity conditions coexist with adjustments in long-term bonds?

By Reporter Ren Fei | Edited by Ye Feng

Last week, international oil prices moved markets, triggering atypical inflation that led many central banks worldwide to consider suppressing rate cut expectations. The Reserve Bank of Australia even announced a rate hike. Against this backdrop, if the market begins to price in stagflation expectations, the marginal easing of liquidity expectations will tighten. This has also caused long-term and ultra-long bonds to experience capital fluctuations. Among bond funds last week, the performance average of medium- and long-term pure bond funds declined, roughly matching that of short-term bond funds.

Rate cut expectations suppressed, adjustments in long-term bonds emerge

From March 16 to 22, market expectations regarding inflation began to shift. Particularly, due to sharp oil price increases combined with geopolitical disturbances, rising industrial costs have prompted discussions about rate hikes.

On March 17, the Reserve Bank of Australia announced an increase in the official cash rate from 3.85% to 4.10%. Previously, influenced by rising oil prices and global energy market volatility, Australia’s inflation pressures had intensified. Economists generally predict that the RBA may raise rates to prevent further inflation escalation.

Prior to this, the global trend was generally towards rate cuts. However, rising oil prices pushed up industrial costs, and rate hikes could suppress apparent inflation expectations. Yet, such expectations might only be reflected at the oil price level, not through a bottom-up liquidity improvement.

In fact, the bond market also reflects this pessimistic outlook. Last week, 1-year government bonds fell by 2 basis points to 1.26%, 3-year bonds fell by 2.5 basis points to 1.35%, 5-year bonds remained unchanged at 1.56%, and 10-year bonds rose by 1.6 basis points to 1.83%. This indicates that long-term bonds declined significantly last week, with yields beginning to rise.

Although the expectation of rate cuts was suppressed, all bonds experienced rising yields and falling prices. Due to differing duration effects, long-term bonds are more sensitive. Simply put, when rate cut expectations are suppressed or even rate hike expectations increase, the market perceives higher future interest rates, causing long-term yields to jump directly.

From the fund performance perspective, the average performance of medium- and long-term pure bond funds declined sharply, narrowing the previous lead over short-term funds. Wind statistics show that top-performing medium- and long-term pure bond funds achieved a weekly return of 1.18%, but the overall average was only 0.07%, while short-term bond funds averaged 0.05%.

Note: Top performance products of various public bond funds last week, source: Wind

Domestic liquidity remains ample; future investment strategies should focus on duration control

Repeated inflation expectations suppress rate cut expectations, leading to liquidity tightening. While there are differences between domestic and international situations, industry insiders remind that future bond market strategies should remain attentive to evolving conditions and emphasize duration adjustments.

Internationally, the Fed’s rate cut pace has significantly slowed, with policy paths highly dependent on inflation progress and Middle East developments. At the March FOMC meeting, the Fed kept the federal funds rate target range at 3.5%-3.75%, with a new statement noting that “developments in the Middle East remain uncertain for the U.S. economy.”

Public information shows that Fed Chair Powell stated that policymakers need to see substantial progress in inflation decline before further lowering rates. Following this, U.S. Treasuries experienced sell-offs, with short-term yields soaring to their highest levels since August last year.

In contrast, domestically, the central bank’s open market operations last week involved a net injection of 65.8 billion yuan via reverse repos, with the policy rate unchanged. The 5,000 billion yuan of ongoing reverse repos were reduced by 1 billion yuan. As previously mentioned, short- and medium-term rates declined driven by ample liquidity and regulatory expectations, while long-term rates experienced adjustments due to stronger-than-expected economic data and rising geopolitical tensions in the Middle East.

Dongwu Securities research pointed out that, given oil prices have risen due to geopolitical conflicts, the domestic PPI (Producer Price Index) turning positive earlier than expected. However, whether positive PPI will lead to a sustained downward trend in bonds remains uncertain. Under such ambiguity, the bond market lacks a consistent narrative and direction.

In the short term, the bond market lacks a clear long-term logic. It is recommended to monitor whether the rebound in PPI year-over-year can shift from external stimuli to internal catalysts. The 10-year government bond yield may remain within the 1.8%-1.85% range over the next month.

Nuoxin Fund analysis indicates that recent bond market movements have been oscillating with slight weakness, with short- and medium-term bonds outperforming long-term bonds. Considering that the overall economic fundamentals are still recovering, the central bank is likely to maintain a loose policy stance, and interbank liquidity should remain stable. Portfolio management should focus on asset price risk-reward, maintain liquidity, and flexibly adjust duration based on market conditions.

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