Credit bond allocation remains a focal point for fixed-income investors as markets navigate shifting macro conditions and evolving supply-demand dynamics. With interest rates expected to trend sideways or lower and liquidity remaining relatively ample, credit bonds continue to offer attractive income opportunities. However, nuanced differences across maturities, credit ratings, and sub-sectors suggest a selective, strategy-driven approach is essential.
This analysis explores key drivers shaping credit bond performance in the second half of 2025—interest rate trends, supply-demand balance, and relative value across sub-markets—while offering actionable guidance on timing, duration, and risk management.
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Interest Rate Outlook: Supportive for Credit Carry
The macro backdrop in the second half of 2025 points to continued monetary accommodation and stable funding conditions. Central bank policy is expected to remain dovish, supporting a loose liquidity environment. In this context, interest rates are likely to trade in a narrow range with a gradual downward bias.
This combination of easy money and range-bound yields enhances the appeal of credit bonds’ carry return, making them a compelling source of income. As long as default risks remain contained, the credit spread (the yield premium over government bonds) can stay compressed, especially in higher-quality segments.
However, a caveat exists: the cushioning effect of coupon income against valuation volatility is weakening. With yields already low across the board, even small rate moves can trigger sharper price swings. This increases the importance of duration management and liquidity positioning, particularly for portfolios with unstable liabilities.
Supply-Demand Dynamics: Limited Supply, Selective Demand
Supply Side: Shrinking Local Government Financing Vehicle (LGFV) Debt Offset by Industrial Issuance
On the supply front, net issuance of credit bonds is unlikely to surge in the second half of 2025. While industrial enterprise bonds may see moderate growth, this will be partly offset by a continued contraction in LGFV (commonly referred to as "city investment" or "local government platform") debt issuance due to tighter regulatory scrutiny.
Importantly, industrial bonds typically offer lower coupons than their LGFV counterparts. This means that high-yield credit supply remains scarce, reinforcing the value proposition of existing higher-coupon names—especially those rated AA or AA(2) with maturities between 1 and 3 years.
Demand Side: Wealth Management Products Face Structural Constraints
On the demand side, retail wealth management products (WMPs) remain major buyers of credit bonds. Historically, WMP assets under management (AUM) tend to grow significantly in July—the start of the third quarter—before slowing through August to December.
This seasonal pattern suggests strongest technical support for credit bonds in July, followed by waning buying pressure later in the year. Moreover, a key regulatory deadline looms: by December 31, 2025, all WMPs must fully eliminate "net value smoothing" practices. This will reduce their appetite for long-duration, low-rated, or illiquid bonds, which are more prone to valuation swings.
As a result, demand for ultra-long or lower-tier credits could weaken in Q4, increasing rollover risks and widening spreads in those segments.
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Strategic Allocation: Timing and Tenor Selection
Given these dynamics, timing and tenor selection become critical levers for return optimization.
- July: Favorable supply-demand conditions support further narrowing of credit spreads, especially in short-to-medium duration buckets. This is an ideal window to add exposure.
- August onward: Consider gradual profit-taking, particularly in low-rated, medium-to-long duration and ultra-long bonds, where spreads are already tight and demand momentum is fading.
- September–December: Reduce overall credit exposure and rotate into safer, more liquid assets such as interbank certificates of deposit (NCDs) and interest rate bonds.
Relative Value Across Maturities and Ratings
Not all credit segments are equally attractive. A closer look at spread valuations reveals clear differentiation:
- 10-year high-grade bonds: These offer the largest potential for spread compression. As of June 30, 2025, high-grade medium-term note (MTN) 10Y credit spreads remain 8–11 bp above historical averages and 20–30 bp above the “mean minus one standard deviation” level.
- Shorter maturities (1Y): Spreads are already tight—below historical averages by 1–2 bp—leaving little room for further tightening.
- Mid-dated bonds (3–7Y): High-grade spreads are slightly above the lower statistical band (by 2–9 bp), while lower-rated urban investment bonds (5Y) trade 11–13 bp above that level.
This suggests that while short-end valuations are stretched, the long-end offers more upside, provided investors can manage interest rate risk.
Tactical Strategies for Different Investor Profiles
1. Short-Duration Downgrade Strategy: Balancing Yield and Safety
For most investors, a short-duration downgrade strategy—extending modestly into slightly lower-rated but still investment-grade credits—remains a balanced approach. Focus on bonds with yields between 2.0% and 2.2%, which aligns with typical performance benchmarks for minimum-holding-period wealth products (e.g., 2.15%) and daily-open products (e.g., 1.80%).
Specific opportunities exist in:
- 1–3 year AA/AA(2) industrial bonds, with outstanding volumes exceeding RMB 900 billion and RMB 1.1 trillion respectively.
- These instruments offer decent yield enhancement while maintaining relatively strong liquidity and resilience during market stress.
2. Tactical Entry into 5-Year High-Grade Bonds on Dips
For higher-rated 5-year bonds (AAA/AA+), current spreads are below historical averages (AAA: 34 bp; AA+: 44 bp), limiting immediate appeal. However, when spreads widen to mean +1 standard deviation or beyond, these levels historically present attractive entry points.
Market data shows that once AA+ 5Y spreads exceed this threshold, they typically snap back quickly—a pattern that supports an active, contrarian buy-on-dips strategy.
3. Selective Participation in Long-End Credit
While 10Y high-grade bonds have room for spread tightening, two headwinds exist:
- Absence of a clear downtrend in long-term interest rates.
- Weaker demand for ultra-long credits compared to 2024.
Thus, long-end exposure should be limited to accounts with stable liabilities and executed with a short holding period—a “in-and-out” trading approach rather than a buy-and-hold stance.
The Rise of Credit Bond ETFs: A New Demand Force
Exchange-traded funds focused on credit bonds—including upcoming sci-tech innovation bond (科创债) ETFs—are gaining traction. These products offer:
- Low fees
- High portfolio transparency
- Efficient trading mechanisms
As their assets grow, they increase demand for index constituent bonds, enhancing their liquidity and price performance. Evidence from June 2025 shows that for maturities under five years, constituent bonds in benchmark market-making indices outperformed non-constituents in yield decline. This effect was less pronounced beyond five years.
Investors should monitor ETF inclusion lists for potential alpha-generating opportunities.
Bank Capital Bonds: Limited Spread Room but Solid Carry
Bank capital instruments—such as secondary capital bonds and perpetual notes—face tighter spread compression potential. The current 5-year AAA- secondary capital bond spread stands at 34 bp, only 16 bp above its historical low.
Yet structural demand from insurers and wealth managers for long-dated paper is declining, suggesting actual compression may be smaller.
That said:
- 4-year and 6-year tenors offer attractive riding returns.
- Short-duration perpetuals (e.g., 1–2 year AA-) provide yields above 2%, with tighter spreads versus secondary capital bonds (10–14 bp advantage), making them efficient carry assets.
Frequently Asked Questions
Q: When is the best time to invest in credit bonds in 2025?
A: July offers the most favorable conditions due to strong seasonal demand from wealth management products and supportive liquidity.
Q: Are long-duration credit bonds still worth buying?
A: Only selectively. While 10Y high-grade bonds have spread compression potential, they require stable funding and active trading due to weak investor demand and rate uncertainty.
Q: What's the safest way to capture yield in credit markets?
A: Focus on short-duration (1–3Y), slightly downgraded (AA/AA-) bonds yielding 2.0–2.2%, particularly those included in ETF indices for added liquidity support.
Q: How will regulatory changes affect credit bond demand?
A: By December 2025, wealth management products must stop smoothing net asset values, reducing their appetite for volatile or illiquid bonds like low-rated long-duration issues.
Q: Is now a good time to buy bank perpetual bonds?
A: Yes, especially short-dated AA- perpetuals, which offer yields above 2% and better spread advantages over secondary capital bonds than longer-dated peers.
Q: What are the main risks to credit bond performance?
A: Key risks include unexpected monetary tightening, liquidity shocks, and broader-than-expected credit defaults—particularly in stressed local government financing platforms.
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Core Keywords
credit bonds, yield curve, credit spread, bond ETFs, bank capital bonds, interest rate outlook, duration strategy, fixed income allocation