Key Considerations for Credit Bond Investment
As we progress into the second half of the year, credit bond investors should focus on three critical factors:
- Monetary conditions and interest rate trends
- Supply-demand dynamics of credit bonds
- Relative value across bond categories
Interest Rate Outlook
Expect continued modest declines in interest rates, with:
- Loose liquidity sustaining low credit spreads
- Reduced cushioning effect from coupons, potentially increasing valuation volatility
Supply-Demand Dynamics
Supply Side
- Industrial bonds offsetting reduced LGFV (local government financing vehicle) issuance
- Overall supply likely restrained due to lower industrial bond yields
- Scarce high-coupon assets persist
Demand Side
- Wealth management product (WMP) inflows typically peak in July (quarter-start effect)
- Demand weakens August-December as WMP growth slows
Regulatory changes (100% NAV smoothing elimination by December) may reduce appetite for:
- Ultra-long duration bonds (high volatility)
- Lower-rated medium/long-duration bonds (illiquid)
Optimal Allocation Strategy
Timing Recommendations
| Period | Action | Rationale |
|---|---|---|
| July | Favorable conditions for credit bonds; modest spread compression | Strong WMP inflows support demand |
| August | Begin profit-taking (especially lower-rated/long-duration bonds) | Spreads near historic lows; weakening WMP demand |
| Aug-Dec | Shift to NCDs/government bonds | Reduced credit bond attractiveness |
Relative Value Analysis (as of June 30)
10-Year Corporates Offer Best Value
- High-grade 10Y spreads remain 8-11bp above historical average
- 20-30bp above -1SD threshold
- Other tenures trade below average spreads
Short-Duration "Reach-for-Yield" Strategy
- Target AA/AA(2) 1-3Y bonds yielding 2.0%-2.2%
- Ample selection: ¥902bn (AA) and ¥11,686bn (AA(2)) available
High-Grade 5Y Entry Points
- Optimal when spreads reach +1SD above mean
- Current levels (AAA 5Y: 34bp; AA+ 5Y: 44bp) suggest waiting for adjustments
Sector-Specific Opportunities
Ultra-Long (10Y+) High-Grade Bonds
- Potential: Significant spread compression space
Challenges:
- Lack of sustained long-end rate declines
- Weaker demand vs. 2024
- Recommendation: Stable-liability accounts may consider short-term trading
Credit Bond ETFs
Growing popularity due to:
- Low fees
- Transparent holdings
- Efficient trading
- Component bonds often outperform peers (5Y- components saw 6bps greater yield drop vs non-components)
Bank Capital Bonds
| Strategy | Current Status | Recommendation |
|---|---|---|
| Trading opportunities | Limited spread compression (5Y AAA- at 34bp vs 18bp historic low) | Focus on 4Y/6Y roll-down |
| Short-duration carry | AA- perpetuals (1Y: 2%+ yield, 10-14bp spread premium over Tier2) | Prefer 1-2Y AA- perpetuals for cushion |
Risk Management
- Monitor unexpected monetary policy shifts
- Watch for liquidity disruptions
- Stay alert to credit events
FAQ Section
Q: Why reduce credit exposure after July?
A: WMP inflows typically slow post-July, reducing demand support as spreads approach historic lows.
Q: Which bonds offer the best downside protection?
A: 1-3Y AA/AA(2) bonds (2-2.2% yield) combine decent carry with short duration.
Q: How to approach bank capital bonds?
A: Favor 4Y/6Y roll-down strategies and short-duration AA- perpetuals for carry.
👉 Discover optimal bond strategies for volatile markets
👉 Master credit spread trading with our institutional-grade framework
Strategies reflect market conditions as of July 2025. Always consult your risk parameters before execution.