Why are ultra-long bonds so strong?

Recently, the bond market has continued to strengthen, and the yields of bonds of various maturities have fallen rapidly, among which the interest rate of ultra-long bonds has fallen most obviously, and the spread between 30-year and 10-year treasury bonds has continued to shrink, constantly hitting record lows.

So what is the reason behind such a rapid decline in ultra-long bonds, whether they have been overtraded, and how to judge the subsequent trend?

In this regard, Guosheng Securities pointed out in Monday's report that variables such as turnover rate, capital price and supply can provide sufficient explanations for the current ultra-long bond market, and the current low ultra-long bond spread is mainly caused by the sharp increase in the turnover rate, and behind this is the change in market style. The sharp increase in the 30-year turnover rate reflects the investment enthusiasm for ultra-long bonds, which is behind the market's preference for high-yield, long-term assets in an environment of sharply falling interest rates.

Specifically, Guosheng Securities pointed out that, first of all, the high price of funds led to a relatively flat curve, which depressed the spread between ultra-long bonds and long-term bonds.

From the empirical data, there is a significant negative correlation between the 30-year and 10-year Treasury bond spreads and R007, indicating that the fund price has a significant impact on the slope of the curve. Since August 2023, there has been a more significant increase in funding prices, which has raised short-end interest rates and formed a relatively flat curve. Although the price of funds has declined in January 2024, it is still at a high level overall. Higher funding prices form a more plateau curve, and at the long end, it is reflected in the continued narrowing of the spread between 30-year and 10-year Treasury bonds.

Second, the supply of ultra-long-term bonds has slowed down, and the shortage of long-term assets has intensified. Guosheng Securities said:

At the beginning of the year, banks and insurance institutions usually have a "good start" in deposits and premiums, and the expansion of the liability side promotes the strong allocation force.

From the perspective of the stock structure of ultra-long bonds, local bonds are the main type of ultra-long bonds, and the issuance of local bonds will account for 85% of the issuance of ultra-long bonds in 2023. The slow pace of local government bond issuance has led to a significantly weaker net financing of government ultra-long bonds than seasonality.

Corresponding to the net financing of government bonds at the end of the year and the beginning of 2022 will be 477.7 billion yuan and 474.2 billion yuan, and only 147.9 billion yuan in 2023. The end of the year and the beginning of the year are the traditional allocation points of insurance and banks, and there is an asset shortage of ultra-long bonds.

Thirdly, the biggest change is also the most important, the decline in risk appetite has led to a surge in the enthusiasm for ultra-long bond trading, and the turnover rate of ultra-long bonds has risen sharply. Guosheng Securities pointed out:

Recently, the turnover rate of ultra-long bonds has risen sharply, and the turnover rate of 30-year treasury bonds is measured by the turnover rate of new bonds and sub-new bonds, and the average monthly daily turnover rate of 30-year treasury bonds has increased from 9.5% in October 2023 to 26% in January 2024.

The recent weakness of the equity market, the weak price of commercial housing, and the downward trend of risk-free interest rates, etc., the current long-term bond assets have "dividend" varieties, which have attracted some equity investors to participate in the bond market, so the turnover rate and volatility of ultra-long bonds have increased significantly.

Regarding whether long-term bonds have been over-traded, Guosheng Securities believes that with a shortage of assets, it is reasonable to accelerate participation in ultra-long-term bond transactions:

The compression of ultra-long bond spreads is due to fundamental factors such as the relatively flat curve caused by high capital prices and the mismatch between supply and demand caused by the slow pace of local bond issuance, but the most obvious change is the increase in the turnover rate of ultra-long bonds due to the decline in market risk appetite. From the perspective of cash flow structure, ultra-long bonds are similar to a "dividend strategy", and the current 30-10 year interest rate spread is still reasonable before the current market pattern changes.