Brief introduction of the guest and moderator
Deng Mingming
With 10 years of experience in the securities industry, he joined Penghua Fund in January 2019 and began to manage the fund in June of the same year, and currently serves as the assistant general manager and fund manager of the first bond investment department. As of the latest data in the first quarter of 2024, Deng Mingming has 9 funds under management, with a total scale of 40.4 billion yuan.
Zhao Jing
Bond researcher of the Fixed Income Research Department of Penghua Fund.
Deng Mingming's golden sentence
1. Liquidity must be considered when analyzing the current bond market or the bond bull market in the past, because the cost of financing is a very powerful driving force for the entire bond yield to fall.
2. When the volatility of the overall financing cost decreases, we can buy some bonds with relatively generous spreads to gamble on the market where the spreads will compress after the volatility drops.
3. Duration can be understood as a low-cost leverage, and when leverage is added, the duration will naturally increase. In this case, everyone spontaneously formed a state of giving up leverage and increasing duration, which also boosted the depth of this round of bull market or whether there was a certain amount of advance in disguise.
4. Defend to a certain extent during the offensive process, and adopt a dumbbell-shaped structure in the combination building strategy, that is, configure the short end and long end, or even the short end and the super long end. When there is a certain risk in the market, the long-end and ultra-long-end bonds are sold, and the whole portfolio will quickly enter a defensive state.
5. We must keep trying to increase or decrease positions in this market. From the perspective of investment practice, "getting off" is not necessarily bad, but it is more important to "get on the bus" again after the reassessment inflection point has not arrived, so that most of the gains in the bull market can be captured.
Zhao Jing: The theme of today's exchange is bond investment strategy from the perspective of liquidity, some friends who have just entered the field of bond investment may be relatively unfamiliar with the concept of liquidity, can you briefly introduce to us what is liquidity~
Deng Mingming: Liquidity is a macroeconomic concept, and there were some so-called definitions before, but it really developed in Keynes's book "The General Theory of Employment, Interest and Money", and then it became a familiar economic term. Previously, liquidity was mainly defined as the ability to liquidate assets, but Keynes diverged it and turned it into the amount of money and credit, a term more macroeconomic. For bond investors, we are also very concerned about the liquidity of the bonds they hold, that is, the so-called former liquidity concept, but it is more of the latter macro liquidity concept that drives the change of bond yields, and the core consideration is the discretionary funds held by micro entities. This definition is also divided into narrow and broad senses, the narrow sense refers to the liquidity of the banking system, such as excess reserves, and the broad sense of liquidity generally refers to the liquidity of the real sector, such as the indicators of M2 and social finance, which are often talked about.
In fact, many financial concepts do not have a particularly strict definition, and even if there is a very strict definition, it is difficult to make a particularly clear distinction in practice, and I believe that liquidity is a similar concept.
Zhao Jing: The traditional bond market investment framework generally studies the bond market from four dimensions, including fundamentals, capital, policy and sentiment. Since the beginning of this year, the economic fundamentals have not changed much, and various policies are basically within expectations, mainly driven by capital and sentiment. You have conducted in-depth research on liquidity, how do you see the changes in the capital side of the entire bond market this year and its impact on the bond market?
Deng Mingming: Actually, the bond bull market since December last year is beyond the framework of our previous analysis of the bond market. The historical bottom of the 10-year government bond was 2.5%, and the economic situation in 2016 and 2020 was more severe than this year, but it did not break through 2.5% at that time, but reached 2.5% and began to gradually rise. When the 10-year government bond broke through 2.5% in January this year, the entire economy did not show particularly large fluctuations, and the policy was relatively stable, and there was not even a single policy interest rate cut. This makes one wonder why, in such a macro and policy environment, the 10-year Treasury bond has so easily fallen to 2.5%, and further to 2.3%, and has not returned to 2.5% in the short term.
Through analysis, I think the liquidity factor behind this has a very big impact, to give a simple number, the bond market to measure the interbank financing cost of the indicator is DR007, from the beginning of December last year to the middle of January this year, this indicator fell from about 2% to about 1.8%, the financing cost of interbank non-bank institutions is usually expressed by R007, this indicator fell from 2.4% in early December last year to about 2% in February this year, down 40bp. The 10-year government bond has fallen from 2.7% to 2.3% from the beginning of December to the present, which is also a range of 40bp.
Regardless of the fundamentals, for non-bank institutional investors like us, the overall financing cost has fallen by 40bp from December last year, which is just in line with the downward range of 10-year Treasury bonds. Therefore, to analyze the current bond market or the bond bull market in the past period, we must consider the liquidity factor, because the financing cost is a very powerful driving force for the entire bond yield to fall, and the 40bp decline in financing cost has driven the bond yield down 40bp, so we have reason to explain that the 10-year treasury bond bull market may be driven by liquidity reasons.
Zhao Jing: Understood.
Deng Mingming: In my research, I also found that there has been a very special phenomenon in terms of liquidity this year, and the volatility of financing costs has decreased a lot, for example, in the past, at the end of January and mid-February, that is, around the Spring Festival, the cost of funds often climbed, but this year, although there has been a certain increase, the increase and volatility are much smaller than in the past. On the other hand, this suggests that the volatility of the overall cost of bond financing is decreasing, and from a more intuitive perspective, it means that the predictability of our borrowing costs is much more predictable, and this decline in volatility could explain some of the logic of spread compression. Theoretically, when the financing cost is constant, all interest rate spreads can be compressed, and the best performing bonds this year, such as 30-year treasury bonds and some medium and long-term credit bonds, are also very closely related to liquidity, especially the decline in the volatility of financing costs.
Zhao Jing: Understood. From your point of view, we can see that liquidity has had a very big impact on the bond market this year.
Deng Mingming: The core premise of the liquidity trading strategy is the operational objectives of the monetary policy of the central bank (i.e., the People's Bank of China). From 2019 to 2020, the monetary policy objectives of our central bank, including operational objectives, intermediary objectives and final objectives, will be updated, and from then to now, the operational goal of the entire central bank's monetary policy is to make the market interest rate fluctuate around the policy interest rate, of which the market interest rate is the DR007 just mentioned. Since it fluctuates up and down around the policy rate, there is a volatility range, so we can build the basis of the entire trading strategy based on the volatility range. At the same time, there are not only banking institutions in this market, but also non-bank institutions, the financing cost of non-bank institutions is determined by the margin, and the widening or narrowing of the interest rate differential between non-bank financing costs and bank financing costs also constitutes the second level of our trading strategy, that is, the marginal pricing factor also has a range of fluctuations and the volatility of capital financing costs.
Briefly summarize these three strategies: first, the return of the financing cost of the game bank to the policy rate, for example, the current policy rate is 1.8%, DR007 is 2%, and there is a 20bp interest rate difference in the middle, so there is a certain room for negotiation. Second, the interest rate spread between the non-bank financing cost and the bank financing cost is compressed, for example, the current borrowing cost of fund companies and fund products is 2.2%, and the 1.8% or 1.9% of the borrowing cost between banks also has a 20-30bp spread, and this interest rate spread also has some room for compression. Third, if the volatility of the overall financing cost decreases, we can buy some bonds with relatively generous spreads to play the market of interest rate spread compression after the volatility declines.
Zhao Jing: As you mentioned earlier, R007 has fallen sharply since the beginning of this year, and DR007 has also lost its elasticity, which reflects that the capital side is looser than the seasonal reality, but at the same time, the central bank's policy interest rate has not been adjusted since August last year, and the OMO repo rate and MLF interest rate have remained at the level of 1.8% and 2.5%, which has constrained the price of funds to a certain extent. Especially in the context of the continuous decline of medium and long-term interest rates, the market has gradually shown the characteristics of "expensive funds and thin spreads", and the interest rate spread between 10-year treasury bonds and DR007 has also compressed from 80BP at the beginning of the year to around 40BP now. I would like to ask you, is this situation of "expensive funds and loose funds" caused by the loose monetary policy of the central bank? Or is it caused by the relatively weak demand for money in the real economy and money, which leads to the obstruction of capital transmission?
Deng Mingming: I personally understand that there are two levels of expensive funds and loose funds. Let's first talk about the problem of capital loosening, which can be explained by the traditional framework. The PBOC clearly pointed out in its previous monetary policy implementation reports that the fluctuation of funds comes from three aspects: first, the injection and recovery of base money; second, the rhythm of fiscal revenue and expenditure, that is, the increase and decrease of fiscal deposits; and third, some non-seasonal and temporary shocks. Aside from the third factor, the first two factors can explain the phenomenon of loose funds in the past quarter or so, for example, the central bank has been very strong in the past period of time to put in the base currency, the net amount of MLF in December last year was 800 billion, in January this year it was 200 billion, and in February it was reduced by 0.5%, which is actually a very big supplement to the base currency. In the fourth quarter of last year, we issued 1.4 trillion yuan of refinancing bonds and 1 trillion yuan of special government bonds, and if you look at the data, these bonds were not used up last year, and some of them were only spent in the first quarter of this year. From this point of view, it actually provides a relatively abundant base currency supply, and we estimate that the scale is at least more than 1 trillion. The combination of the two can tell you very clearly that in the past 3-4 months, both at the central bank level and at the fiscal level, there has been a very large supplement to the base money, which can explain the phenomenon of monetary easing very clearly.
However, I think it is difficult to understand the reason for the high cost of funds with the traditional framework, for example, the current overnight funding price exceeds the policy rate of the 7-day reverse repo, and for example, the overnight financing cost is about 1.8%-1.9%, but the policy rate of the 7-day reverse repo is only 1.8%, which is relatively rare in history. It is also difficult to explain the phenomenon of expensive funds with a clear framework or good tools, and it may take a while for the data and theory to be significantly updated before the real cause can be discovered.
On the whole, I think that the loose and expensive capital may be a short-term phenomenon, because it lasts for about a quarter, and then either the capital price gradually rises, and the asset price adjusts with the capital price, or the capital price gradually falls, and the asset price follows the capital price again, and the yield continues to fall. Now that the overnight fund price is higher than the seven-day reverse repo policy rate, if we think in the opposite direction, is it possible for it to go further up? If it is a very normal monetary policy operation framework, the space for it to go up is relatively limited, and if we limit and control the space for it to go up further, we can inference that the overall risk of the bond market is not so great at present, because the entire financing cost has reached a relatively high level.
Zhao Jing: You just mentioned that the phenomenon of "loose capital and expensive capital" has also lasted for more than a quarter, I would like to ask, what impact do you think such an environment has had on the trading structure of the entire market?
Deng Mingming: This is a very interesting question, after it lasts long enough, market investors will spontaneously adjust their investment rhythm and portfolio structure according to this phenomenon, there are probably three very interesting phenomena:
First, after a period of loose funds, everyone will form a bull market thinking, that is, as long as the funds are not tight, the risk of bonds is not large, and the same as the idea of analyzing the overnight repo rate and the 7-day policy rate just now, forming an unbreakable bull market thinking.
Second, funds are still very expensive, which means that the carry spread is very low, for example, the yield of the two-year CDB bond is only about 2%, but the overnight financing cost is about 1.8%-1.9%, and the interest rate spread is very thin. In this regard, the market has also made certain adjustments and gradually removed leverage. We often see that as bond yields continue to fall, the level of leverage is constantly rising, but this year there has been a very opposite phenomenon, bond yields are going down, the bull market is moving forward, and the money-making effect is constantly improving, the leverage is declining, which is somewhat contrary to the phenomenon of the past period or the past few years, indicating that when the carry spread is very low, everyone gives up leverage and turns to find a strategy to increase duration. The 30-year and 10-year Treasuries performed very well, and the reason behind them was that investors spontaneously increased their duration. Duration can be understood as a very low-cost leverage, so when leverage is added, the duration will naturally increase. In this case, everyone spontaneously formed a state of giving up leverage and increasing duration, which also boosted the depth of this round of bull market or whether there was a certain amount of advance in disguise.
Third, some phenomena of this round of bond market conditions are beyond the previous analytical framework, and at this time, it is necessary to carry out a certain defense in the process of attacking, and adopt a dumbbell structure in the so-called portfolio construction strategy, that is, to allocate the short end and long end, or even the short end and the ultra-long end, when the market once there is a certain risk, the long end and the ultra-long end bonds will be sold, and the whole portfolio will quickly enter a defensive state. The dumbbell strategy is used a lot, which is reflected in the market changes that this round of bull market has not fallen, but it has not fallen deep every time, and the yield may turn downward immediately after a few days of adjustment, the essential reason is that everyone is bullish, but in fact there is a trace of fear, so the dumbbell strategy is adopted, resulting in the bond market can quickly enter a new platform after selling, and the motivation to increase leverage again is very strong, and the whole market will be boosted again.
Zhao Jing: Understood. In the long run, bonds are a type of "strong momentum" asset, with a strong trend, and the so-called bull market is a big trend, but the market does not have a permanent trend. From a megatrend perspective, this bull market has been going on for more than three years, and long-end yields have reached a record low, how do you understand the relationship between liquidity and trend investing?
Deng Mingming: For this very classic question, first of all, we can combine some liquidity indicators and bond yield indicators, so that we can see the inflection point of the past few rounds of bulls and bears, whether it is from bull to bear or from bear to bull, behind it will be accompanied by the liquidity inflection point, either liquidity from loose to tight, or liquidity from tight to loose. Although it is a concomitant phenomenon, it can also be understood that the liquidity inflection point drives the inflection point of bond yields, because since the formulation and implementation of the new central bank operating framework in 2019, liquidity has become a very important and even the most important driving factor in the bond market. At this point, we will draw a point of view, if this round of bond bull market is driven by liquidity, then at the end of the day there will be an inflection point in liquidity, if liquidity has been loose, the pace of the bull market may not stop, this is the relationship between liquidity and bond yields or bond bull and bear market switching.
This may lead to another question – how can we determine the current liquidity inflection point. We will have some daily tracking indicators, but most of these indicators are synchronized, and it is difficult to predict the liquidity inflection point in advance. How to use these indicators in practice comes to the second question you just mentioned, when the indicators change, we will inevitably wonder if there is an inflection point in liquidity, whether the duration should be reduced for defense, which forms the "off" behavior in the trend. When we judge that the liquidity inflection point has not appeared, but is just a seasonal reason or a temporary shock, we will "get on the bus" again and increase the duration again, which is formed because you judge that the dominant factor of the bond is liquidity, and the liquidity indicator is a synchronous indicator, it is inevitable that we will "get on and off" frequently in the whole market.
From a comforting point of view, "getting on and off" is actually normal, because it is difficult for us to stand at the beginning of December and predict a bond bull market of about 40bp in the next 3 or 4 months. Therefore, we must keep trying in this market and keep increasing or decreasing positions. From an investment practice point of view, "getting off" is not necessarily bad, but it is more important to "get on the bus" again after the reassessment inflection point has not arrived, and then you can capture most of the gains in the bull market.
Zhao Jing: You just mentioned that "the trend is tried, and the important thing is not to get on and off the bus in the trend, but to get on the bus after re-evaluation", and the key here is "evaluation". Focusing on the liquidity issue we discussed, in the traditional funding framework, if we want to evaluate the future liquidity situation, we generally mainly consider the pace of interest rate bond issuance, the pace of fiscal delivery, the derivation of credit, the liquidity of the central bank, and hedging. Judging from the current situation, the government work report of the two sessions this year mentions that 1 trillion special treasury bonds will be issued, and the market is generally expected to issue them in the second quarter. In addition, we also observed that the issuance of local bonds in the first quarter of this year was relatively slow, and the overall issuance volume was far less than that of last year, and the issuance of local bonds may also be accelerated in the second quarter. Do you think the large-scale issuance of interest rate bonds in the second quarter will break the "low elasticity of the capital side" mentioned in the first quarter, and will there be a return to the seasonality of the capital side in the second quarter?
Deng Mingming: I think there is a possibility, the characteristics of both loose and expensive capital may be short-term factors, when we add the new factors of bond issuance, it may break the short-term equilibrium, but this equilibrium has two important premises: the first premise is the aforementioned rhythm of fiscal revenue and expenditure, after the debt is issued, it may be used quickly, so in the current month or the next month, the impact of fiscal revenue and expenditure on liquidity is not so big. The second very key premise, I think, is the central bank's hedging operation, if the central bank does a lot of liquidity hedging after the bond issuance in May and June, such as hedging through MLF, OMO, or even using RRR reduction to hedge, the impact on liquidity or the impact of bond issuance on liquidity will not be so great.
If this is the case, the expected increase in volatility may not necessarily occur, combined with the content of the conversation just now, because we can rely on seasonal factors and institutional behavior factors when tracking liquidity, it is difficult to have some forward-looking indicators, so we will constantly adjust our investment strategy according to real-time changes.
Zhao Jing: You just told us how to predict the capital situation from a qualitative point of view, and I would like to ask if there are some quantitative indicators that can help us track the capital situation, for example, from the current situation, is there an inflection point in liquidity?
Deng Mingming: There are many quantitative indicators, but the core is still the volume and price indicators. In terms of quantity, I pay more attention to the amount of financing of various institutions and the difference between it and seasonality, and the core consideration is the willingness and ability of various institutions to lend out, which is a very important factor in our perception of micro liquidity. The second is price, we can observe the changes of DR/R/GC these fund price indicators to provide a macro view of liquidity, and it is also a more synchronous indicator. At the same time, because interbank certificates of deposit are a very sensitive part of a bank's liabilities, it could be very helpful in liquidity guidance if we take out some seasonal factors. At present, the liquidity indicators that everyone tracks are similar, and the core is to combine some indicators to make a comprehensive judgment.
Zhao Jing: I see, your insights on liquidity are very unique and wonderful. Finally, I would like to ask you what you think about the capital and bond market in the second quarter.
Deng Mingming: I think there is a high probability that the capital will remain stable in the second quarter, which is in line with the central bank's mention of "maintaining reasonable and abundant liquidity". Actually, the focus is not on the pivot of the funding rate, because in the second quarter we will face the impact of the April tax payment, including in June, and there will be some end-of-quarter shocks. But I think one of the core factors is the volatility of the capital side, if the volatility is still at a relatively low level, and DR007 is at 1.8%-1.9% Such a central bank's consensus range, then it can correspond to the current asset price, whether it is the short end or the medium and long term, at least it will not trigger the risk of a sharp adjustment in the bond market, but if there are some unexpected factors or the central bank's monetary policy has a more obvious relaxation of this, it may lead to a downward shift in the repo rate, which in turn will drive bond yields downward.
To sum up, first of all, I think that the overall volatility of funds will be relatively stable like in the first quarter, but it cannot be ruled out that there is a downward trend of the center. In terms of bond yields, the price of the entire fund may still be high, and there may not be so much room to continue to go up, so the overall bond yield is still in a state of shock and downward movement, and the whole market may be in a bullish atmosphere.
Source: wind.
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