Yongmei shock unlikely to recur; bond market difficult to replicate year-end 2020 conditions

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Last week, Vanke’s extension became the focus of the market. Some investors compared it to the Yongmei default event in 2020, worrying that the bond market may once again see the large-scale adjustment seen in that year.

In its latest research report, Orient Securities conducted an in-depth comparative analysis and concluded that the current situation is essentially different from the end of 2020. The extent to which Vanke's extension alters market expectations of fundamentals is limited and unlikely to trigger systemic risk transmission.

Orient Securities believes this credit event will not significantly change the main trading theme of the bond market. The likelihood of allocation funds from banks and insurance companies accelerating their entry is quite low. The bond market may continue to fluctuate with a weak bias in December.

The Essence of the Yongmei Impact

The market habitually extrapolates linearly, benchmarking Vanke's extension against Yongmei’s default in November 2020, but such concerns seem unfounded.

Orient Securities points out that the destructive power of the Yongmei event that year stemmed from the sudden collapse of “state-owned enterprise faith,” resulting in emotional shock and a subsequent negative feedback from wealth product redemptions. By contrast, the current weakening of fundamentals is market consensus and is not enough to trigger systemic redemptions.

In its report, Orient Securities states:

The huge impact of Yongmei’s default on November 10, 2020 came primarily from its breaking the market’s “faith” in AAA-rated provincial state-owned enterprises. As the largest coal company in Henan Province, Yongmei had stripped away loss-making units and injected fresh capital before the default, so the event exceeded market expectations.

The chain reaction in the credit bond market spread quickly. The week of the default, yields on 1-year AAA and AA+ medium-term notes rose by 14.4 and 17.4 basis points respectively; throughout November, the maximum increases reached 28 and 54 basis points. Concerns rapidly transmitted from credit bonds to rates bonds and the money market, creating two impacts: First, fund products faced redemption pressures, forcing the sale of more liquid rates bonds, thus creating a “selling-net value drop-redemption intensifies” negative feedback loop. Second, the money market saw the rare phenomenon of intensified mid-month stratification.

It’s worth noting the central bank responded quickly to the volatility triggered by the Yongmei event, and the situation also calmed down rapidly. The central bank began increasing liquidity injections the week of the default: From November 11th to 13th, reverse repo net injections turned positive, totaling RMB 280 billion, and on November 16th, a net RMB 600 billion Medium-term Lending Facility (MLF) injection. Funding rates quickly dropped from highs, with DR007 and R007 returning to pre-default levels by November 17th. The negative feedback in the bond market gradually dissipated after the Financial Stability Committee undertook stabilization measures on November 21st.

However, the deeper reason for the significant decline in the bond market at the end of 2020 lay in how the Yongmei event altered market expectations for the macro environment. The event occurred amid continued economic improvement in the second half of 2020, with the market expecting ongoing tightening by the central bank. The exposure of credit risk broke that expectation, prompting the market to reassess the sustainability of economic recovery and the direction of monetary policy, which was the fundamental reason for the large-scale fall in bond yields.

The 2020 Market Scenario is Hard to Repeat

Comparing the current situation, the Vanke extension event is unlikely to have the same systemic impact. The report emphasizes that the central bank acted swiftly during the risk event back then, while this time, due to the limited spread of risk, “the money market and bond market face little negative feedback pressure, so there is no need for major central bank injections or regulatory stabilization statements.”

Specifically, Orient Securities believes that, firstly, the weakening trend in real estate fundamentals is already market consensus. Although the timing of the extension exceeded expectations for some investors, it did not break any major “faith”—the resulting panic is clearly lower than happened with Yongmei. Even if the credit spread widens in the short term, the degree will be limited, and the probability of spreading to interest rate and funding markets, thus triggering redemption pressure, is weak.

Secondly, since credit risk is only spreading to a limited extent, there is little negative feedback pressure on the funding and bond markets, and there is no need for major central bank interventions or regulatory stabilization. Last week’s bond market adjustment was mainly due to instability on the liability side of fixed-income products and continued concerns about new fund regulations, rather than the Vanke incident itself. In the second half of the week, as rates adjusted to highs, long-term bonds led a marginal recovery in spot bonds, with 10-year government and policy bank active bonds moving by 1.7 and 2.5 basis points compared to the previous week, to 1.83% and 1.90% respectively.

Most importantly, this event is unlikely to alter market expectations for the macro environment, and will not, like Yongmei, prompt investors to reassess the economic outlook and direction of monetary policy, nor will it drive institutions such as banks and insurers to accelerate their entry into the bond market.

December Bond Market: Controllable Funding Pressures

Looking ahead to December, funding pressures are expected to be manageable. This week’s rates bond issuance scale fell to RMB 456.7 billion, a medium level for the period, with government debt supply pressures under control. In addition, fiscal expenditures tend to increase toward the year end, so the money market may experience some seasonal volatility, but overall pressure is weak. Last week, the central bank net injected RMB 55.8 billion through open market operations. Funding rates diverged, with DR007 fluctuating between 1.45% and 1.47% and end-of-month cross-month trading remaining basically steady.

However, Orient Securities notes that overall trading opportunities in the bond market remain limited. Expectations for a rise in the long-term rate center may exert an early dampening effect on market sentiment for the remainder of the year. Last week, yields rose across all maturities, with the largest increase in the 7-year government bond yield, up 3.8 basis points.

In summary, investors should not simply apply the experience of late 2020, expecting credit risk events to create significant trading opportunities in the bond market. The current market environment, nature of events, and macro expectations all differ fundamentally from that time, and it is more rational to take a cautious view of the trading value in December’s bond market.

Risk Warning and DisclaimerThe market involves risks; investments should be made with caution. This article does not constitute personal investment advice and does not take into account the unique investment goals, financial situations, or needs of individual users. Users should consider whether any opinions, views, or conclusions in this article are suitable given their specific circumstances. Investments made based on this information are at one's own risk. ```