The financial landscape in recent times has been influenced by a confluence of factors, creating an intricate tapestry of shifts in both bond and equity markets. Since the beginning of this year, we have witnessed a tightening in the funds supply alongside data from the economic fundamentals that have surprised analysts on the upside. Moreover, the bullish sentiment taking root in the stock markets has also contributed to constraining the performance of the bond market.

The current state of the yield curve for government bonds can be characterized as bearish with a flattening tendency. This situation invokes a careful consideration of future prospects. In the short term, the yield curve remains susceptible to rebound risks, with notable attention warranted towards the longer maturities as they face the risk of further declines. Speculation points to a possible upper limit of 1.8% for the yield on ten-year government bonds.

Taking a look back, it becomes clear that since late last year, the interplay of currency stabilization pressures and the need to avoid a rapid descent in long-term interest rates has led to a tightened liquidity environment. This predicament cascaded into rising short-term interest rates, which have since permeated into the longer-term yields as well.

In late 2022, the People's Bank of China adopted a cautious approach in its monetary policy with respect to liquidity injections. This resulted in an observable increase in the short-term rate as the average rate of the interbank borrowing system (DR001) surged from approximately 1.5% at the end of last year to above 1.8%. Likewise, the one-year government bond yield ascended by over 30 basis points to surpass 1.4%, while the yield on the ten-year note edged upward by 10 basis points to hover around 1.7%.

Moreover, aside from the tightening of the funds, the improvement in economic fundamental data and a palpable uplift in stock market sentiment have served as significant influences on the dynamics of the bond market. January's inflation data reflects a degree of stabilizing pressure on the consumer price index (CPI), which rose by 0.4 percentage points year-on-year to achieve 0.5%. Core CPI has consistently increased for four straight months, with remarkable performance seen in sectors such as education, culture, and entertainment.

Additionally, January's financial data has also exceeded expectations, illuminating both quantitative and structural aspects positively. Notably, the total social financing increased by 583.3 billion yuan year-on-year, alongside a significant uptick in credit, which surged by 210 billion yuan. Middle to long-term enterprise loans also demonstrated an impressive addition of 150 billion yuan relative to the previous year's figures. The implementation of new policies has played a vital role in expediting project launches by governmental entities, creating robust support for credit expansion.

The encouraging CPI figures alongside an unexpected increase in lending have softened the outlook of bond market investors, somewhat counteracting the prevailing bearish sentiment. As stock markets continue to rally, these developments collectively influence the bond market's trajectory.

From a short-term vantage point, the yield curve for government bonds exhibits a bear-flattening pattern, with significant rebound risks still in play. The sustained tightening of liquidity in the financial sector has rendered the current yield curve starkly different from its state at the year's outset, revealing pronounced increases in the medium and short durations. The long and ultra-long maturities exhibit some resistance to declines but have also started to rise recently.

With liquidity conditions still tight, there remain substantial rebound risks for the yield curve. The historical precedent suggests that if we use the benchmark of OMO (Open Market Operations) plus 50 basis points to define the reversal upper limit, we should expect the ten-year government bond yield may encounter a ceiling near 1.8%, factoring in approximately 20 basis points of potential cuts.

As we delve into the medium to long-term view, the prevailing conditions suggest that the bull market for bonds is not yet over. The increases in funding rates are capable of nudging short-term yields higher independently of any fundamental support, yet for a significant rise in long-term yields, positive macroeconomic conditions are essential. Historically, such periods of continuous funding rate increase have led to notable upward movements for one-year government bonds; however, only a few instances have shown similar effects on the ten-year bonds—most notably during the third quarter of 2020 and the first quarter of 2021 when GDP indices were robust, contrasting the current economic scenarios.

Interestingly, the recent follow-up of long-term bond yields could present a timely opportunity for investors. While the timing for the easing of fund supply remains ambiguous, caution is essential, and a smoother allocation strategy should be employed. Compounding these factors, recent currency fluctuations have seen a strengthening trend, with bond market leverage remaining relatively subdued. The central bank's rationale for tightening liquidity appears to be geared towards thwarting a decline in government bond yields and, in this regard, targets seem to be met, although careful attention should be given to the potential negative feedback effects from rising rates.

In summary, the recent tightening of liquidity coupled with January’s favorable inflation and credit data has imposed restrictions on the bond market’s performance. The yield curve currently embodies a bearish flattening state while, looking ahead, the short-term perspective hints at potential rebound risks. Moreover, employing the OMO plus 50 basis points model suggests a likely upper limit of 1.8% for the ten-year bonds in this round of rebound. However, from a medium to long-term viewpoint, the bond bull market appears far from over, indicating that there remains considerable opportunity for bullish positioning throughout the year.