On February 18, the A-share market experienced a downturn, and the bond market also faced further corrections, with government bond futures dropping across the board. This downward trend encompassed long-term bonds, which had previously shown resilience. Most government bonds in the interbank market across various maturities displayed a notable increase in yield, signifying a shift in investor sentiment.

Several fixed income analysts expressed that despite the expectation of continued loose monetary policy in the long term, fundamental shifts in the market landscape had not yet materialized. There is still a scarcity of assets, but the current environment seems to have intensified the tug-of-war between long and short positions in the bond market. With reserve requirement reductions anticipated before long, liquidity conditions are expected to remain tight, leading to an upward movement in the yield curve.

Recently, the Ministry of Finance announced that they would conduct market support operations for government bonds, specifically targeting the February 2025 maturity. This operation involves selling 8.9 billion yuan of securities, primarily focused on 2-year and 3-year products. Market participants perceive this as a routine measure that can help adjust the supply-demand dynamics for specific bond types and enhance liquidity within the secondary market, albeit with limited impact on the broader direction of the bond market.

On February 18, government bond futures opened in weakness and slightly rebounded in the afternoon, but ultimately closed lower across the board. By the end of the trading day, the key thirty-year contract fell by 0.32%, the ten-year contract decreased by 0.17%, the five-year contract dropped by 0.07%, and the two-year contract declined by 0.04%. Notably, the thirty-year contract had already lost 2% over the past three trading days.

In trading activities, most government bond yields in the interbank market saw increases, with the one-year and five-year active bonds rising by 4 basis points and 1 basis point, respectively. The ten-year active bond saw substantial trading volatility but ultimately closed unchanged at a yield of 1.67%, while the thirty-year yield retreated marginally to 1.882%, down by 0.8 basis points.

Prior to this, on February 17, the Ministry of Finance issued a notice regarding the market support operations, announcing the sale of government bonds with maturities of 2 years and 3 years for 5.2 billion yuan and 3.7 billion yuan, respectively, which would be conducted through competitive bidding on the morning of February 18. Analysts from brokerage firms commented that these operations are part of a routine mechanism, assessed in conjunction with market supply-demand conditions and the Central Bank's liquidity management practices. They noted that there is a clear shortage of cash in the interbank system, making market reaction to these announcements more sensitive. However, the primary impact of these operations is localized, focusing on adjusting the supply-demand dynamics for the specific securities involved, with limited broader implications for the bond market's overall performance.

Revisiting recent history, the Ministry of Finance and the Central Bank established a government bond market support mechanism in September 2016. This initiative was aimed at enhancing liquidity in the secondary government bond market and accurately reflecting the supply-demand relationship through an improved yield curve. This is a tactic commonly employed by developed nations to ensure the healthy functioning of their sovereign bond markets.

The mechanism specifies that when a critical maturity bond faces weak demand in the secondary market, indicating a significant supply-demand imbalance, the Ministry of Finance may step in to purchase those bonds from market makers, known as “buy operations.” Conversely, if there's a shortage of available bonds, the ministry will sell an appropriate quantity of bonds to support liquidity, termed “sell operations.” According to officials from the Ministry of Finance and the Central Bank, the operational scale will typically not be large and will take into account factors such as central treasury funds forecasts and interbank liquidity considerations, thus ensuring minimal disruption to the broader banking system's liquidity.

On February 18, the Central Bank engaged in a substantial 489.2 billion yuan seven-day reverse repo operation. This action came alongside the maturity of 330 billion yuan in reverse repos and 500 billion yuan in Medium-term Lending Facility (MLF) notes, effectively leading to a net withdrawal of 438 billion yuan from the market. Following the Lunar New Year holiday, the week of February 5 and the subsequent week witnessed net withdrawals of 1.0213 trillion and 470.9 billion yuan, respectively, through open market operations.

As tax deadlines approach and local bond issuance increases, market participants are closely observing the Central Bank’s next steps in open market operations. Consensus is growing regarding a slowdown in the pace of easing monetary policy, particularly concerning reserve requirement ratio cuts. Analysts predict that until such cuts are implemented, liquidity will likely remain tight, further pushing yields upward and tempering overly optimistic expectations for capital gains within the bond market.

In a climactic reflection of the market dynamics, many interbank pledge-style repo rates continued to move higher on February 18. The weighted average of the DR001 rate increased by 2.69 basis points to 1.9655%, while the DR007 surged by a striking 28.8 basis points to 2.3447%. Overall, rates across markets exhibited varied movements, with significant fluctuations reflected in the Shanghai Stock Exchange GC001 and GC007 rates, as well as Shen Zhen Stock Exchange R001 and R007 rates, indicating a complex interplay of factors impacting liquidity and yield expectations.