Fixed Income Reviewing Bond Market Volatility in Terms of Financial Security

ArnslyslZHANG JiqiangSAC No.SD57051811C002SFC No.AMB145zhangjqiangghtso.cam+(86) 10 6321 1166 Huatai Research 13 August 2024 | China (Mainland) Weekly Ourcoreviews The financial system exhibits pro-cyclicalcharacteristics, and central bankregulation plays a crucial role in maintaining financial stability and policy credibilty.the PBoC is unlikely to make significant interest rate adjustments, in our view. Wecontinue to project a range of 2.1-2.4% for ten-year government bond yield andrecommend closely monitoring the trend of wealth management (WM)redemptions and observe further policy developments. The dumbbell porffoliostrategy may offer the most attracfive value, providing sufficient liquidity andoperational flexibility. If the trend sustains, we anticipate substantial marketadjustments could present valuable investment opportunities. Pro-cyclicalfeaturesforboththefinancial system&capital market There is a dynamic feedback loop between the financial system and the realeconomy, which amplifies cyclical fluctuations. This phenomenon also applies towhich drive asset prices higher, creating a reinforcing cycle. A notable example iscapital markets, including bond markets. Rising asset prices attract capital inflows,the rise in core assets in the stock market from 2020 to 2021, In the bond market, asimilar cycle has occurred: declining interest rates over the past two years haveled to strong performance in fixed-income WM products, while deposit interestrates have continuously decreased, attracting significant capital inflows into WMproducts, thus further expainding the WM market and driving interest rates down. Pro-cyclical risks from rapidly declining long-term bond rates in 2024Firstly, small and medium-sized insurers face potential risks from interest spreadlosses. Over the past two years, the rapid decline in ssset-end interest rates hasoutpaced the decline on the liability side, leading to the accumulation of interestremaining relatively high, many institutions seek to increase their allocation ofspread loss risks. Secondly, with liability costs for small and medium-sized bankslong-term interest rate assets for capital gains. However, this strategy may weakenasset-liability matching and exacerbate tail risks. Thirdly, with strong historicalperfomance, WM products has attracted unstable inflows such as corporatedeposits. If interest rates reverse, it could trigger redemption feedback. PBoC managing long-term bonds for risk prevention &credibility As the lender of last resort, the central bank holds the responsibility of stabilizingthe macroeconomic environment and mitigating market fluctuations. For theregulation to be effective, it is necessary to alter the supply-demand dynamics orthe fundamental conditions of the bond market, including monetary policyexpectations. Should these measures prove insufficlent, what supplementary toolscould be employed? One option is to directly tighten liquidity. Another is for thePBoC to borrow bonds and sell them. A third option is to continue issuing window Eyeing onfollow-on economic&fiscal initiatives Currently, the economic fundamentals are still in a phase of recovery amidfluctuations, which does not support the introduction of contractionary policies bythe central bank. Going forward, it will be important to closely monitor economicconditions and leverages its infuence effectively, the policy impact willikely bemore pronounced, in our view. Risks: monetary policy easing exceeding our. expectations,; stricter financialregulations than we expect. Disclaimers Analyst Certification about the subject securities or issuers; and no part of the compensation of the analyst(s) was, is, or wll be, directly or indirectly.related to the inclusion of specific recommendations or views in this report. General Disclaimers and Disclosures This research report has been prepared by Huatai Financial Holdings (Hong Kong) Limited (hereinafter referred to as “HFHL").The information herein is strictly confidential to the recipient. This report is intended for HFHL, its clents and associated This report is based on information deemed reliable and publicly available by HFHL, but HFHL and its associated company(les) The opinions, assessments and projections contained herein only reflect the views and judgments at the issuance date. Huataitimes. The prices, values and investment returns of the securities or investment instruments referred to hereln may fluctuate.Huatal makes no warrants that the information in this report be kept up to date. The information contained in this report may bemodified without notice by Huatal, and investors shall pay attention to such updates or modifications when necessary. HFHL is not a U.S. Financial Industry Regulatory Authority (°FINRA') member firm, and HFHL research analysts are notregistered/qualified as research analysts with FINRA. While every effort has been made by Huatal to ensure the content contained herein is objective and impart