The bond market has encountered some turbulence since August, causing concern among investors who find themselves facing losses in their bond fundsThis raises an important question: Is the bond market still a worthy investment option? After analyzing the current landscape, the conclusion reveals a cautious but optimistic stanceDespite limited fluctuations in interest rates and a firm economic outlook—along with the central bank's evident intent to support liquidity—the allure of the bond market remains intact, mainly due to an ongoing "asset shortage" that sustains demandNevertheless, the bond market has started to exhibit a more diverse performance across different types of securities.

To better understand the dynamics at play, it's essential to differentiate between interest rate bonds and credit bondsInterest rate bonds, commonly backed by government credit, are seen as low-risk investmentsThis category primarily includes government bonds, municipal bonds, central bank bills, and policy financial bonds—which are issued by state-owned banks like the Export-Import Bank of China, Agricultural Development Bank of China, and the China Development BankThe perceived security associated with these bonds stems from their governmental backing.

On the other hand, credit bonds are issued by corporate entities, which adds layers of complexityThese can be further classified into financial bonds issued by financial institutions and corporate bonds issued by non-financial entitiesDue to the varied creditworthiness of these companies, the risk associated with credit bonds can differ significantlyGenerally, corporate bonds tend to offer higher yields compared to government bonds, with the difference in yield referred to as the credit spreadThis is calculated by combining the risk-free rate, the credit spread, and liquidity premiumsWhile interest rate bonds typically present lower risks due to their government backing, credit bonds potentially yield higher returns but come with increased risks correlated to the issuing entities’ financial health.

The recent divergence within the bond market calls for further examination

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Recent trends indicate that the different categories of bonds are responding distinctively to market conditionsFor instance, between August and late August 2024, the total wealth index for state bonds rose by 0.16%, while the corresponding index for credit bonds fell by 0.15%. The stark contrast in performance highlights that credit bond funds and related investment products have been lagging compared to pure interest rate bond products.

Two contributing factors help explain this segmentation: Firstly, the adjustments in credit bonds can be attributed to a correction of earlier trendsAs early as July, there were multiple warnings concerning risks that appeared to impact interest rate bondsA sharp decrease in market activity—evidenced by a decline in transaction volume—has left credit bonds more vulnerable to increased liquidity pressuresConsequently, some investors, nervous about these developments, opted to liquidate their positions preemptively.

Secondly, the prevailing credit spreads for credit bonds had compressed to historically low levels, making them highly sensitive to even marginal changesThroughout this year, compounded by the "asset shortage" scenario, credit spreads have continued to tighten, leading to minimal differential returns compared to risk-free alternatives like government bondsThis situation heightens the vulnerability of credit securities to fluctuations in market conditions.

Moreover, government bond issuance has accelerated in recent weeks, potentially tightening liquidity conditionsFrom August onwards, both national and local governmental bond issuances significantly ramped up, with net financings reaching approximately ¥1.73 trillion by late AugustWhen ultra-low credit spreads coincide with tightening liquidity, the widening of credit spreads becomes a natural outcome as investors reassess risk in a modified environment.

Given these dynamics, one might wonder why investors would not instead favor the more stable policy financial bonds

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