On August 30, 2024, the People's Bank of China (PBOC) issued Announcement [2024] No. 1 on the trading of treasury bonds. According to the announcement, in August, the central bank adopted the operation method of buying short-term government bonds and selling long-term government bonds. The purpose of this operation is twofold: to buy short-term Treasury bonds in order to increase the base money supply in the market; The purpose of selling long-term government bonds is to prevent a possible long-term government bond bubble and maintain the stability of financial markets. Such a buy-sell mix helps keep the Treasury yield curve trending normally upward.

Throughout August, the central bank achieved a net injection of base money through the net purchase of 100 billion yuan of bonds. This indicates that the central bank intends to continue to implement an accommodative monetary policy, and it is expected that the treasury bond buying and selling business may continue to be in a state of net buying for some time to come. In addition, the PBOC chose to announce the operation of the whole month on the last trading day of the month, indicating that it may continue to issue monthly announcements on treasury bond sales in the future.

Why did the central bank start the daily operation of treasury bond trading?

First, China's monetary policy still has room to operate normally. The central bank is enriching its policy toolbox by buying and selling government bonds, which is a new way to increase the supply of base money. Compared with traditional instruments, the central bank has more flexibility in the time and covers a wider range of maturities in the open market, so it can be used as an effective supplement to other ways of disbursing base money.

Second, the central bank's initiation of treasury bond trading operations in the secondary market is a necessary step to shift to price-based regulation. The Treasury yield curve will become one of the important targets of monetary policy operations. In this process, the policy rate, the interest rate corridor and the transmission mechanism of interest rates from the short term to the long term are the key factors to achieve price control.

Among them, the Treasury yield curve will play an important role in this transmission mechanism and become one of the targets of the central bank's attention. Central banks may want to maintain a normal upward pattern of the yield curve to ensure a positive incentive for investment, ease pressure on banks' net interest margins, and achieve voluntary rate cuts. At present, the central bank guides the Treasury yield curve through tools such as reverse repo, medium-term lending facility (MLF) and Treasury bond trading, but in the future it may gradually shift to a method that mainly relies on reverse repo and Treasury bond trading.

Finally, the buying and selling of government bonds is also a meeting point for the synergy between monetary and fiscal policies. The central bank can smooth out the liquidity shock caused by the concentrated issuance of government bonds by buying and selling government bonds, and prevent sharp fluctuations in the price of funds. The upcoming meeting of the Standing Committee of the National People's Congress on September 10 and the meeting in October will be important times to see if new fiscal instruments will be introduced. At that time, the central bank may increase the purchase and sale of treasury bonds in the open market to match the implementation of fiscal policy.

How do you view the central bank's purchase of 400 billion yuan of special treasury bonds?

On August 29, the Ministry of Finance issued a special treasury bond that matured and renewed, which was issued to specific banks. At the same time, the central bank conducted an open market operation and bought 400 billion yuan of special treasury bonds. This directional issuance of special government bonds will not affect market liquidity, because it is issued on a rolling basis, the central bank has not expanded the size of its balance sheet, and the treasury has not increased the deficit.

It is worth noting that the 400 billion yuan of special treasury bonds purchased by the central bank this time are unlikely to become part of the regular open market treasury bond trading. If the central bank sells these special treasury bonds in the secondary market, the ultimate holders will be transferred from the central bank to financial institutions, enterprises and individuals, which will change the function of these special treasury bonds from a fiscal revenue transfer tool to an open market financing tool. This would break the link between government bonds and CIC's assets, and would change the way CIC pays its profits and the Treasury repays its debts.

If these special treasury bonds are sold through a one-time sale, theoretically speaking, the issue of repayment of principal and interest, which was originally handled by internal bookkeeping between the central bank and the Ministry of Finance, will become the need for the Ministry of Finance to repay principal and interest to other institutions, enterprises, and individuals. This may require adjustments to budget lines and a reconsideration of whether they should be included in the deficit. Such a situation may need to be submitted to the National People's Congress or its Standing Committee for consideration.

For these reasons, we believe it is unlikely that the central bank will sell this special treasury bond in the future. In addition, this operation was not included in the "Announcement on the Trading of Treasury Bonds in the Open Market" newly established by the central bank.

Monetary policy outlook and its impact on investment?

The counter-cyclical "tailwind" has begun, and the PBOC has three paths for monetary easing: interest rate cuts, RRR cuts, and government bond trading. In the second quarter monetary policy implementation report released by the central bank, based on the assessment of the domestic and foreign economic and financial situation, the central bank believes that it is currently in a "tailwind" environment suitable for the implementation of counter-cyclical adjustment. In particular, when the Fed's interest rate cut in September was almost a foregone conclusion, China's monetary policy space was further expanded and its policy autonomy was enhanced.

Considering the large maturity of the medium-term lending facility (MLF) in the remaining months of the year and the peak of government bond financing, there is still a need to further release medium- and long-term liquidity in the future, so the likelihood of a RRR cut increases, which is expected to be between 25 and 50 basis points. In addition, the 7-day reverse repo (OMO) rate and the loan prime rate (LPR) are also likely to be lowered in September, followed by a decrease in the MLF rate, which is expected to be around 10 to 15 basis points. If these rate cuts are implemented, the 10-year Treasury yield could fall to a range of 2.0% to 2.1%.

In the context of loose monetary policy, it is expected that the central bank will continue to buy government bonds on a net basis during the year to increase the supply of base money.