Zhong Ou Fund's Bond Market Read: Debt De-risking Is Still Mid-Course

At Zhong Ou Fund's 20th anniversary strategy event, Wang Shen, head of fixed income research and a fund manager, said China's debt de-risking process is only at the middle stage, which underpins a medium-to-long-term low interest rate environment. He argued the bond market performed better than expected in the first half of 2026, returned to the stable characteristics of fixed income, and is now generally priced at reasonable levels.

Wang framed the macro picture through three lenses. Household debt service ratios have fallen from their peak but remain above what he considers a comfortable level; his model projects a return to normal only from the end of 2027 to the first half of 2028, which he links to the bottom of the property cycle. Government debt resolution is also unfinished. On the corporate side, listed companies excluding finance, oil and petrochemicals spent roughly ten quarters in active capacity de-risking from the second quarter of 2023 to the first half of 2025. Since the third quarter of 2025, earnings have shown low-level stabilization, but broad capacity expansion has not restarted.

He described the split as new economy leading growth and profit, while the traditional economy leads debt financing. He also said the 2025 second-half bond correction occurred because the 10-year government bond yield had traded below bank funding costs, creating a pricing bubble; after yields recovered above bank funding costs, the bubble was cleared. For the remainder of 2026, he expects low rates to persist and pure bonds to remain a stable core allocation, though absolute returns likely fall short of the first half.

Why Wang Shen Sees a Split Between New Economy Earnings and Traditional Debt Financing

Why Household and Government Deleveraging Anchor the Low-Rate Base Case

Wang's DSR argument is not just a demand forecast; it is a timing estimate. If households are still spending a larger share of disposable income on debt repayment than is sustainable, the property market's true bottom remains farther out. His estimate of the end of 2027 to the first half of 2028 matters for credit risk and rate expectations. The interpretation is that investors should not read the recent corporate earnings stabilization as evidence the entire economy has turned; consumer balance-sheet repair is still incomplete.

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Corporate Capacity De-risking: The Old-New Economy Divide

The presentation's factual claim is that A-share non-financial, non-oil listed companies de-risked capacity for nearly ten quarters. The analytical point is that only part of the corporate sector has regained the ability to expand. Wang contrasted traditional industries, where return on invested capital still sits below financing costs and therefore cannot support new capacity, with AI, advanced manufacturing, robotics and new energy, which he sees as the main sources of profit growth. That split implies bond and equity exposures should not be viewed as a single China macro trade.

What the 2025 Repricing Tells Investors About Current Bond Valuations

Wang's explanation of the 2025 second-half correction centers on a concrete anchor: bank funding costs. When the 10-year yield was below that cost, institutions had little economic reason to hold bonds; the correction pushed yields back above the threshold. He treats this as a successful bubble clearing rather than a change in the low-rate regime. The near-term return question is therefore more modest: if bank funding costs continue to fall in the second half of 2026, pure bonds can still work, but the absolute return is likely lower than the first half's surprise.

What Institutional Investors Should Test Before Treating Bonds as Core Allocation

For institutional fixed-income and multi-asset teams, the presentation offers specific claims to test rather than generic guidance:

  • Stress-test the 2027 to 2028 DSR timeline. Wang's model puts household debt service normalization at the end of 2027 to the first half of 2028, implying the property cycle bottom lags the current earnings stabilization. Use that timing in credit and duration scenarios.
  • Distinguish old-economy credit from new-economy exposure. His claim that traditional industry return on invested capital remains below financing costs means capacity expansion has not started; credit selection should treat AI, advanced manufacturing, robotics and new energy as a different risk profile.
  • Rebuild bond return assumptions. Wang expects pure bonds to remain a core allocation but with lower absolute returns than the first half of 2026, so model lower return expectations rather than extrapolating the first half.
  • Track bank funding cost declines. The current bond valuation anchor is the 10-year yield above bank liability costs; further declines in bank funding costs in the second half of 2026 would be the main support for prices.