Treasury Yields Rise Amid Asset Scarcity

The phenomenon of too much currency chasing too few bond-like assets has led to a financial environment characterized by an asset shortage, making it increasingly difficult for bond yields to rise significantlyIn recent years, particularly since the beginning of 2024, the bond market has experienced a notable upward trendThe yield on the ten-year government bond has fallen from approximately 2.55% at the start of the year to about 2.10% currently, with the thirty-year bond yield similarly decreasing from around 2.85% to 2.35%. This decline in yields has been accompanied by a significant compression of credit spreads.

Multiple factors have contributed to the formation of this bond bull marketIt is not only a reflection of structural transformation within the economic development mechanism but is also affected by both internal and external growth cycles

However, the decline in interest rates can also be seen as a monetary phenomenonIf the driving forces behind inflation are described as “too much currency chasing too few goods,” the motivational factors behind declining interest rates can be articulated as “too much currency chasing too few bond-like assets.” This perspective on the asset shortage adds another layer to interest rate analysis.

Coincidentally, during the first two decades of the twenty-first century, a similar scenario played out internationally where bond yields exhibited an inclination to decline but found it challenging to recoverVarious academic explanations have emerged to elucidate this trendNotably, former Federal Reserve Chairman Ben Bernanke proposed the “global saving glut” theory, attributing low interest rates to imbalances in current accounts

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He argued that emerging markets in Asia, seeking to build international reserves, reduced imports while increasing exports, leading to persistent trade surpluses that favored allocations toward safe assets like U.STreasury bonds, thus resulting in long-term low interest rates.

Conversely, researchers at the Bank for International Settlements (BIS), including Borio et al., posited that the demand for safe asset allocation does not predominantly stem from emerging market surpluses but rather from the monetary activities of the European banking sectorEuropean banks obtained U.Sdollar funding through wholesale markets and subsequently issued U.Sdollar loans, thereby contributing to the shadow banking system in the U.SWhile net cross-border flows indicated balance in current accounts for Europe and America, substantial expansion in banking scale led to massive total cross-border capital movement

Thus, they proposed that the source of asset shortages is not merely surplus savings, but rather excessive creation within the global banking system.

Applying this theory to analyze China's recent asset shortage scenarios reveals intriguing insightsDuring the years 2015 to 2016, the rapid development of interbank business mirrored these global dynamicsA typical model of interbank expansion involved banks issuing interbank certificates of deposit to acquire funds, which were then invested in either bond outsourcing or interbank wealth management products to generate returnsGiven that interbank assets do not require reserve deposits, theoretically, banks could significantly expand their interbank assets and liabilities simultaneously, creating substantial amounts of currencyThis expansion was profitable under stable funding rates, establishing a massive demand for bond assets, even resulting in instances where bond yields and the costs of wealth management liability inverted, marking the genesis of the asset shortage during that period.

However, following December 2016, regulatory bodies introduced new asset management rules and increased volatility in funding rates, effectively regulating and curtailing disorderly interbank expansion practices

The asset shortages during 2015 to 2016 primarily arose from currency creation among banks and between banks and non-bank entitiesIn contrast, since 2021, the phenomenon of asset shortfall can be assessed from both monetary and asset anglesFrom a monetary perspective, the rapid growth of bank loans and higher M2 growth must be considered; however, loan growth has been predominantly supply-drivenBanks have been issuing loans at lower interest rates, thereby generating currency, but these loans have primarily relied on speculative demand, leading the created money to flow into time deposits and high-yield investment products, thus resulting in a simultaneous existence of high M2 and low M1 monetary phenomena.

From the asset perspective, there has been a gradual reduction in traditional high-yield assets, particularly those in real estate and local government investments, especially following the introduction of new debt resolution policies for local governments in 2023. The combination of low-interest loans driving currency creation and the transformation of the economic development model resulting in asset shortages has collectively fostered the current asset shortage dynamic.

The emergence of the asset shortage has profoundly influenced the bond market, altering the traditional analytical framework surrounding it

The composition of bond market participants has changed, with rural commercial banks emerging as significant playersFollowing a deposit rate cut in December 2023, rural commercial banks reduced their interest rates relatively slowly, rendering them attractive to depositors, especially with inflows around the Spring Festival periodThis resulted in a robust liability base for rural commercial banks, leading to active bond allocation behaviors in the first quarter of 2024, which in turn triggered a decline in bond market yieldsUnder the auspices of the asset shortage, larger banks and insurance companies have also augmented their proportions of bond-like asset allocations.

The ongoing evolution of the asset shortage will continue to dictate changes within the bond marketThe central financial work conference of 2023 emphasized the need to “revitalize financially stagnant resources, improving the efficiency of fund utilization.” Subsequent central bank actions stressed that “revitalizing stock loans, enhancing the efficiency of current loans, and optimizing new loan directions are equally critical to supporting economic growth.” Consequently, policy approaches that focused heavily on quantity in the early stages shifted toward prioritizing quality while scaling back bank expansions.

The shift in policy thinking has consistently led to a decline in M2 growth since early 2024. Theoretically, the previous phases of bank expansion and increased currency creation brought about heightened allocation capacity

Thus, one might question whether current trends in bank contractions and reduced money supply will subsequently lessen allocation capacity and alleviate the asset shortageHowever, the reality is more complexThe process of banks contracting simultaneously displays trends of financial disintermediation and the expansion of non-bank financial institutionsA prime example occurred in the second quarter of 2024 when regulatory efforts to halt manual interest supplementation resulted in both low-efficiency bank loans and high-yield deposit arbitrage decreasingSimultaneously, capital began to shift from banks to non-bank entities, which proved to have relatively ample resources and exhibited more proactive behaviors towards bond asset allocations, thereby catalyzing a bond market rally driven by non-bank entities.

During the contraction of banks and reduction of money supply, the demand for reserves from banks concurrently drops

This leads to an overall satisfaction of liquidity in the interbank market, causing funding rates to hold steady rather than riseLooking forward, alleviating the asset scarcity will require reductions in money supply alongside increases in asset supplyOn the monetary side, the ongoing process of financial revitalization and the purification of excesses is still underwayMonetary supply has slowed down, yet this has inadvertently led to passive easing of interbank liquidityOnce the purification process concludes, interbank liquidity is likely to establish a new equilibrium alongside money supply.

In terms of asset provision, as governments enter concentrated phases of issuing bonds, a temporary increase in asset supply may alleviate the asset shortage scenario, potentially resulting in a short-lived pulse adjustment in interest ratesHowever, this alleviation may not last long