CICC: Stability in funding is expected to improve, still optimistic about investment opportunities in bonds.

China International Capital Corporation (CICC) released a research report stating that overall, the bank believes that the period of the most tight liquidity conditions is passing, and with the potential for a stronger yuan, fiscal injection, and continued loose monetary policy by the central bank, interbank liquidity is expected to return to a loose state and the stability of the funding situation is expected to improve. This may gradually dispel the current market concerns. Regarding bond investments, if funding rates return to stable levels for the year, the bank believes that short-term interest rates may experience a round of cuts, and there will also be room for further decline in long-term interest rates. In this context, the bank remains optimistic about bond investment opportunities, with limited risks of significant interest rate adjustments. CICC's main points are as follows: Since mid to late August, the central level of money market interest rates has risen slightly and there has been increased market attention to funding conditions, along with an increased concern about funding stability. Looking back, this round of funding tightening can generally be divided into several stages, with different influencing factors during each stage. From mid to late August until mid-September, the main factor was the strengthening of the US dollar, which put pressure on the yuan. Therefore, it was necessary for policy to tighten onshore and offshore liquidity temporarily to support currency stability. In October, there was a combination of special refinancing bonds and increased issuance of national bonds, which pushed up the issuance and net increase of government bonds, leading to increased pressure on interbank liquidity. The abnormal volatility on the last trading day of October was more likely due to information asymmetry between financial institutions and the underestimation of funding tightness by non-bank institutions. Since November, there has been continued issuance of national bonds, which has maintained concerns about funding stability in the market. Although the factors that have led to fluctuations in funding prices since August have had slight differences, they all reflect the pressure on bank excess reserve levels and the uneven movement of liquidity between depositary institutions. Larger banks/policy banks have taken on more responsibilities such as stabilizing the exchange rate, digesting the pressure of government bond supply, and increasing credit lending, and they may face stronger liquidity gaps compared to medium and small banks. Additionally, larger banks usually offer lower funding rates than other medium and small banks, and the decline in the proportion of funding from larger banks will also increase the average cost of funding. With the increased intensity of the People's Bank of China's open market operations, the tight liquidity situation in the interbank market has marginally improved since November, but the medium to long-term interest rates in the money market, represented by the rates of interbank negotiable certificates of deposit (NCDs), have not fallen alongside. The spread between the 1-year AAA-rated NCD and 1-year medium-term lending facility (MLF) has widened. We believe that the deviation between NCD rates and short-term funding rates may be due to banks, especially larger banks, still having a certain funding gap to stabilize liabilities, which exacerbates the supply and demand contradictions of NCDs. From the supply side, the net increase in government bonds has consumed banks' excess reserves passively, boosting their demand for stable long-term liabilities. In addition, considering the constraints of liquidity assessment indicators, banks' demand for medium and long-term stable liabilities has increased. From the demand side, the growth of fixed income asset management products has slowed down, regulatory adjustments, and fluctuations in risk preferences have affected the market's ability to absorb NCDs to some extent. In summary, the constraints that the funding situation currently faces are mainly seasonal and temporary disruptions. We believe that these disruptions are expected to be alleviated to a certain extent within the year. On the exchange rate front, with recent deceleration of the US economy, US bond yields and the US dollar index have both fallen from their highs, relieving pressure on the exchange rate. Coupled with the expectation that some companies may increase end-of-year settlement arrangements under the expectation of a potential peak in the US dollar, liquidity for RMB deposits is expected to improve, allowing banks to replenish some of their funding gaps. On the government bond supply front, on one hand, the issuance of special refinancing bonds is basically coming to an end, and on the other hand, although the issuance of national bonds this year has brought about an additional RMB 1 trillion in payment pressure, considering the subsequent implementation of fiscal injections and the fact that the central bank's reserve requirement ratio was lowered in September and the MLF was continuously renewed in November, this has partly offset the funding gap. Additionally, December itself is a month of large fiscal injections, especially considering the slow progress of fiscal spending throughout the year, there will be significant pressure for concentrated injections of funds at year-end, which may fill a substantial liquidity gap. Furthermore, the most important point is that the PBOC's monetary policy orientation and attitude have not fundamentally changed. With reasonable and abundant liquidity, we believe that the probability of reserve requirement ratio reductions and interest rate cuts still exists within the year. It is also not ruled out that there may be further guidance to lower deposit interest rates, especially considering that the pace of credit lending may be frontloaded, and it is highly likely that the PBOC's liquidity support will continue. In conclusion, we expect that the tight funding situation will gradually improve within the year, especially in the repo market, accompanied by a weakening exchange rate pressure, continuous fiscal injections, and liquidity support from the PBOC. The central level of repo rates is expected to fall back to the level of OMO operating rates. If fiscal injections significantly accelerate, there is no ruling out the possibility of overnight rates returning to the lows of the third quarter. For the NCD market, there may still be some pressure on supply and demand contradictions in the short term, but the subsequent fiscal deposit injections will to some extent alleviate funding gaps. At that time, banks' demand for stable liabilities may weaken marginally, coupled with recent credit spread and term spread compression, the comparative advantage of NCD rates may increase, which may stimulate fund inflows into demand sectors, especially asset management products. Additionally, if banks further lower deposit interest rate curves, their marginal pricing of NCDs will also be driven downwards. Risks: Policy easing is less than expected.