The modern financial landscape has found itself grappling with a phenomenon known as the "asset shortage." This intriguing situation arises when a surplus of currency competes for a limited pool of bond assets, resulting in yield rates that are prone to falling but resistant to risingThis underlying issue has become particularly pronounced in markets since the beginning of 2024.

This year, the bond market has witnessed a significant uptrend, with the yields on 10-year and 30-year government bonds declining from approximately 2.55% and 2.85% to around 2.10% and 2.35%, respectivelySimultaneously, credit spreads have also compressed noticeablyThe factors contributing to this bullish bond market are multifaceted, reflecting structural transformations in economic development mechanisms and influenced by cyclical factors both domestically and abroad

However, it is essential to recognize that declining interest rates represent a monetary phenomenonIf inflation results from “too much money chasing too few goods,” then declining interest rates symbolize “too much money chasing too few bond assets.” This perspective brings into focus the central theme surrounding the current asset shortage.

Interestingly, this is not a novel predicament—during the first two decades of the 21st century, international markets encountered similar issues, characterized by yields that were easily driven down but hard to push upScholars have proposed various explanations for these trendsOne notable hypothesis is the “scarcity of safe assets,” which examines low yields through the lens of supply and demand in the asset marketIt suggests that persistent low interest rates stem from imbalances in the current account

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Emerging market countries, particularly in Asia, have sought to build international reserves, often leading them to reduce imports while boosting exportsThis overabundance resulted in trade surpluses, which in turn drove extended periods of low rates on U.STreasury and other secure investments.

The Bank for International Settlements (BIS) adds another layer to this discourse, positing that the driving force behind the allocation of safe assets does not necessarily come from emerging market trade surpluses, but rather originates from the monetary dynamics of European banking institutionsThese banks functioned in the U.Swholesale market to procure dollar-denominated funds, subsequently disbursing dollar loans that significantly contributed to the growth of the shadow banking system in the United StatesWhile the cross-border net data between the U.S

and Europe may not showcase any significant current account imbalance, the reality is that banks have considerably expanded their scale, resulting in an overwhelming flow of capital between jurisdictions—hence, they argue, the roots of the asset shortage can be traced back to a global banking glut rather than merely excess savings.

Drawing upon this theoretical framework provides insights into two recent occurrences of asset shortages witnessed in ChinaThe asset drought from 2015 to 2016 was largely driven by rapid growth in interbank activitiesAt that time, banks pursued a typical interbank expansion model, issuing certificates of deposit to gather funds which they then channeled towards either bond investments or wealth management productsThe uniqueness of interbank assets lies in their exemption from reserve requirements, permitting banks to manufacture money at an accelerated pace due to the simultaneous growth of interbank assets and liabilities

This scenario generated substantial demand for bond assets, culminating in an inversion of bond yields relative to the costs of wealth management liabilitiesSuch conditions epitomized the backdrop of the 2015-2016 asset shortageMoreover, in trying to stabilize funding rates, volatility eventually surged leading to intensified regulations and controls over disordered interbank expansions.

The asset shortages in 2015-2016 primarily originated from monetary creation processes between banks and non-bank financial institutionsConversely, the asset shortages observed since 2021 reveal a more complex scenario that can be dissected from both monetary and asset-centric viewpointsFrom a monetary perspective, banks have recorded robust loan growth and a high M2 growth rate, yet the increase in loans has been driven primarily by supply-side factorsOn one hand, banks have issued loans at lower rates, creating money; and on the other, a considerable fraction of the loans lacks genuine financing demand, resulting in the newly created money funneling into fixed deposits and high-yield management products

This has produced a monetary landscape characterized by the coexistence of elevated M2 and subdued M1 metricsFrom the asset perspective, as economic growth dynamics evolve, the conventional high-yield assets typified by real estate and local government financing steadily decreaseThis trend has been exacerbated by the 2023 introduction of policies to resolve local governments’ implicit debt, further diminishing the supply of municipal investment assetsConsequently, the monetary creation driven by low-interest loans, coupled with an inevitable asset shortfall induced by transformational shifts in developmental models, has coalesced into the current asset shortage situation.

The formation of this asset scarcity landscape has had significant repercussions for the bond market, altering the traditional frameworks of bond market analysisThe composition of market participants has shifted, with rural commercial banks emerging as key players in the bond market

Following a deposit rate cut in December 2023, rural commercial banks had their deposits adjusted relatively slowly, which rendered them more attractive, especially with the influx of deposits during the Spring FestivalThis situation has resulted in a phase of robust bond allocation behaviors by rural commercial banks in early 2024, leading to a downward trend in bond yieldsIn the context of asset shortages, traditional institutions such as major banks and insurance companies have also increased their allocations toward bond assets.

The evolving narrative of the asset shortage holds considerable sway over changes in the bond marketThe central financial work conference of 2023 highlighted the need to “revitalize underutilized financial resources to enhance the efficiency of fund usage.” In pursuing these objectives, central bank directives have emphasized measures to “revitalize stock loans, ameliorate the efficiency of existing loans, and optimize the distribution of new loans,” establishing equal importance between these three components for sustaining economic growth

This marked a shift in policy thinking from previous emphasis on quantity and bank balance sheet expansions to a more quality-oriented approach that constrains banks' balance sheetsSuch a transition has had a direct impact, resulting in a continuous decline in M2 growth rates since the beginning of 2024.

Theoretically, while previous phases of bank balance sheet expansion and monetary creation increased allocation power, the current phenomenon of reduced monetary supply accompanying the shrinking of bank balance sheets raises the question of whether this will diminish the allocation impulse and alleviate the asset shortage situationHowever, real-world dynamics are not necessarily linearFirstly, as banks retreat from expansion, signs of financial disintermediation, along with expansion in non-bank financial institutions, simultaneously emerge

A poignant example occurred in the second quarter of 2024, when regulatory measures prohibited manual compensation for interestThis policy led to simultaneous contractions in banks' low-yield loans and high-yield deposit arbitrageConcurrently, capital flowed from banks toward non-banking entities, which found themselves relatively liquid and were compelled to pro-actively seek bond assets, thereby creating a bond market driven by non-banking dynamicsSecondly, as banks reduce their balance sheets and monetary supply decreases, the demand for reserves within banks also diminishes, resulting in overall liquidity becoming ample across interbank markets and pushing funding rates down.

Looking ahead, alleviating the asset shortage phenomenon necessitates reductions in monetary supply alongside an increase in asset availabilityOn the monetary front, the current pursuit of financial revitalization and extraction of excesses remains underway, with a noticeable deceleration in monetary supply