Key points
High interest rates in the United States may persist for a longer period of time, but will slowly decline
According to the ACM model of the New York Fed, the US bond interest rate can be further decomposed into the expectation of the future trend of short-term treasury bond bond yield and term premium. The former is mainly influenced by the target interest rate of the Federal Reserve's federal funds. The latter can be seen as compensation demanded by investors to bear the risk of possible changes in interest rates during the bond's term, mainly affected by various uncertainty risks, including inflation and monetary policy risks, economic growth risks, and credit risks.
It is highly likely that the central yield of US Treasury bonds will remain between 3.6% and 4.0% in the next year. In the future, the unemployment rate gap in the United States may increase, but considering the decrease in inflation and monetary policy risks, we expect the center of the term premium to rise to between 0.4% and 0.5%. In addition to the estimation of the forward expectation of the US short-term interest rate, the central probability of the US treasury bond bond yield in the next year will remain between 3.6% and 4.0%, and the trend will be higher before and lower after the Fed's interest rate cut.
The decline in US bond yields may drive the valuation of A-shares to recover
In the future, as US bond yields fall, the valuation of the A-share market is expected to rise. From a historical perspective, the direct impact of US bond yields on the A-share market has been relatively weak, with a greater impact on the valuation of the A-share market. Since 2017, there has been a high negative correlation between US bond yields and the valuation of the A-share market. In the future, as US bond yields gradually decline, the valuation of the A-share market is expected to rise.
The decline in US Treasury yields may boost growth and overvaluation styles. From a historical perspective, the yield of US bonds has declined, with a higher probability of growth style outperforming value style, and a higher probability of overvalued style outperforming undervalued style. However, in terms of market value style, there is no clear pattern in the market performance of large and small cap styles during the downward phase of US bond yields. Therefore, the future decline in US Treasury yields may boost growth and overvaluation styles.
The decline in US bond yields is beneficial for growth industries and companies
Against the background that the future US debt yield is expected to continue to fall, the primary industry suggests focusing on food and beverage, computer, medicine and biology, household appliances and other industries, and the secondary industry suggests focusing on Baijiu, electronic chemicals, components, aerospace equipment, computer equipment, photovoltaic equipment, chemical pharmaceuticals, white household appliances and other industries. Historically, the industries with relatively high proportion of foreign positions and growth industries are relatively more affected by the yield of US debt. In the downward phase of the yield of US debt, food and beverage, computers, medicine and biology, household appliances and other industries have relatively high rising probability. In the secondary industries, Baijiu, electronic chemicals, components, aerospace equipment, computer equipment, photovoltaic equipment, chemical pharmaceuticals, white goods and other industries have relatively high rising probability. Therefore, in the context of the expected continuous decline in US bond yields in the future, it is recommended to pay attention to relevant industries.
At the individual stock level, it is recommended to focus on growth companies represented by high R&D expenses, high revenue growth rate, and high volatility, as well as high beta companies. From a historical perspective, the market performance of growth companies represented by high R&D expenses, high revenue growth rate, and high volatility has shown a high negative correlation with US bond yields. In addition, due to the relatively high proportion of individual investors in the A-share market, high beta companies are prone to oversold and oversold when their risk appetite rebounds or falls. Therefore, historically, compared to low beta companies, high beta companies have been relatively more affected by US bond yields. Therefore, in the context of a gradual decline in US bond yields in the future, it is recommended to focus on growth companies represented by high R&D expenses, high revenue growth, and high volatility, as well as high beta companies.
Risk analysis: 1. The Federal Reserve's interest rate hike process exceeded expectations; 2. The decline in US bond yields is lower than expected; 3. Due to the incomparable macroeconomic environment and market conditions, there is a possibility of the failure of historical statistical laws; 4. The relationship between China and the United States has experienced significant fluctuations.
Main text
01
How much downward space is left for US bond yields?
1.1. From the ACM model, it is highly likely that US bond interest rates will slowly decline
This year, the yield on US Treasury bonds has been affected by the Federal Reserve's hawkish monetary policy and the risk of a US credit rating downgrade. The yield on 10-year US Treasury bonds quickly climbed to nearly 5%. In December, influenced by dovish statements from Federal Reserve officials, US bond yields rapidly declined. Since the second half of this year, the resilience of the US economy has continued to exceed market expectations. Federal Reserve officials have maintained a hawkish stance, coupled with Fitch Ratings and Moody's downgrades of the US credit rating in August and November respectively. Under the impact of risk events, US bond yields have continued to rise. On October 19th, the 10-year US Treasury yield broke the important 5% mark and closed at 4.98%, setting a new record since July 2007. Since mid to late October, as inflation data continues to decline, Federal Reserve officials have begun to signal a pause in interest rate hikes. Powell even hinted in the December interest rate meeting (FOMC) that interest rate cuts could be included in the discussion, and the 10-year US Treasury rate has begun to decline significantly.
The sharp rise and fall of US Treasury bonds since the beginning of this year has attracted widespread market attention and is also one of the important factors affecting the A-share market in the future. The sharp rise and fall of US Treasury bonds since the beginning of this year has attracted widespread attention from the global market. As the anchor of global asset pricing, the impact of 10-year US Treasury bonds on global assets is self-evident. With the increasing internationalization of A-shares, the impact of US bond yields on A-shares is also gradually increasing. The changes in US bond yields have a certain impact on the overall trend, market style, industry rotation, and individual stocks of the A-share market, and are worthy of continuous attention.
To determine the future trend of US Treasury yields, we use the New York Fed's ACM model as the basis to analyze the trend of US Treasury interest rates. According to the ACM model of the New York Fed, the US bond interest rate can be further decomposed into the expectation of the future trend of short-term treasury bond bond yield and term premium. The former is mainly influenced by the target interest rate of the Federal Reserve's federal funds. The latter can be seen as compensation demanded by investors to bear the risk of possible changes in interest rates during the bond's term, mainly affected by various uncertainty risks, including inflation and monetary policy risks, economic growth risks, and credit risks.
Historically, the expectation of the future trend of short-term treasury bond bond yield is basically consistent with the trend of the target interest rate of the Federal Reserve's federal funds. In history, when the federal funds target interest rate remains at its original level or continues to fall, the market's expectation of the future trend of short-term interest rates is likely to decrease accordingly. When the federal funds target interest rate rises, the market's expectation of the future trend of short-term interest rates is likely to increase accordingly.
The future expectation of short-term interest rates is expected to continue to decline. The latest grid chart released by the Federal Reserve shows that FOMC members unanimously believe that the federal funds rate has peaked. The FOMC members have a median expectation of 4.6% for the policy interest rate in 2024, implying a 75 basis point rate cut next year. It can be seen from this that the current Federal Reserve rate hike is nearing its end, and the probability of future rate cuts is greater than rate hikes. If the Federal Reserve starts cutting interest rates, the market's expectations for the future trend of short-term interest rates are expected to decrease accordingly.
The fluctuation of term premium is mainly affected by uncertainty. For term premium, it is an insurance premium against future yield uncertainty compared to the current short-term interest rate expectations. When investors think that the uncertainty of future treasury bond yield is growing, the risk compensation required by investors for bond investment increases, and the term premium tends to rise. Historically, when the implied volatility of treasury bond bond options was high, the term premium rose simultaneously. The uncertainty of US bond yields is often influenced by three types of factors:
1) Inflation and monetary policy risk: When the inflation path in the United States is unclear or there are significant differences in the wording of monetary policy by Federal Reserve officials, the uncertainty of inflation and monetary policy increases.
2) Economic growth risk: When the US economy tends to decline or faces significant uncertainty, the uncertainty of future economic growth increases.
3) Credit risk: When the US fiscal burden or deficit is high, the market becomes concerned about the US government's solvency, and uncertainty increases.
Inflation and monetary policy risks are mainly influenced by fluctuations in inflation data and statements made by Federal Reserve officials. Here, we can use the uncertainty index of CPI difference to approximate inflation and monetary policy risk. Historically, when the index rises, there is significant divergence in the market's path towards future inflation, and further divergence in the outlook for the Federal Reserve's future monetary policy. If the Federal Reserve does not provide clear guidance on monetary policy expectations or adopt corresponding monetary policies to control inflation at this time, the maturity premium of US bonds often rises synchronously. Since the second half of this year, although the overall year-on-year CPI in the United States has maintained a downward trend, the August and September CPI year-on-year data released in September and October have exceeded market expectations, and inflation risks have fluctuated. This also synchronously affected the attitude of Federal Reserve officials and increased market divergence on monetary policy, leading to an increase in term premiums.
Inflation expectations will slowly decline, and inflation risks will gradually converge. According to survey data released by the University of Michigan, consumer expectations for the next year's inflation rate in December 2023 fell to 3.1%, a significant decrease from November's 4.5% and the lowest level since March 2021. The five-year inflation outlook has correspondingly decreased to 2.8%. Due to the decline in energy prices and the apparent effect of the Federal Reserve's interest rate hikes, consumer concerns about inflation have decreased. Therefore, we expect inflation to continue to gradually cool down, and inflation expectations will also slowly decline. As the path of inflation decline gradually becomes clear, inflation and monetary policy risks will gradually converge.
The risk of economic growth mainly reflects the changes in output gaps under different economic cycles in the United States. When the economy enters a downturn, term premiums often rise. Historically, the gap of the US unemployment rate (the US real unemployment rate minus the short-term natural unemployment rate) is more consistent with the trend of the term premium of US treasury bond bonds. When the unemployment gap in the United States increases, the risk of economic growth increases, and investors often need higher premium compensation, leading to an increase in term spreads.
The growth rate of the US economy is likely to continue to decline, and the risk of economic growth will increase, but there is limited room for improvement. The dividend of post pandemic fiscal expansion in the United States has reached its end in the election year, coupled with the near depletion of excess savings by residents, the cooling of consumption will constrain the growth of the US economy. Therefore, the future economic growth rate of the United States is likely to decline, and the unemployment rate will rise. The gap in the unemployment rate may further expand, which will support the rise of the premium on US debt maturity. However, considering that the manufacturing cycle in the United States may begin next year, the return of manufacturing will become the core clue supporting a soft landing of the US economy, so the space for the unemployment rate gap to rise is limited.
When the US government experiences credit events, the term premium increases accordingly. If the shutdown of the US government is used as an indicator to measure the impact of credit risk on the US government, it can be found that as the credit risk of the US government increases, the term premium increases synchronously. From the historical data, the average maturity premium of US debt generally rose during the closing period and within three months after the opening of the door in the seven closing events where the government closed for more than 10 days. The closure of the U.S. government means that it is difficult for the two parties in the United States to quickly compromise on the budget issue in the short term, increasing investors' concerns about the U.S. fiscal issues. The market tends to be cautious about investing in U.S. treasury bond bonds, and the term premium rises accordingly.
The US government deficit will remain high, but credit risk events have been released this year, reducing the likelihood of similar events happening again. Due to the heavy debt burden of the US government, Fitch Ratings and Moody's downgraded the US credit rating in August and November respectively, prompting US bond investors to demand more risk compensation and push up credit risk premiums. Looking back, although the US government's fiscal deficit will remain high, the risk of a downgrade in the US credit rating has been released, and the probability of similar risk events occurring in the future will be reduced.
The recent trend of US bond yields has mainly fluctuated with term premiums, and since September, high market uncertainty has driven up US bond yields. By disassembling the yield of US treasury bond bonds, we can find that the recent trend of the yield of US treasury bonds mainly follows the term premium. In the second half of this year, the market's tolerance of the Federal Reserve's inflation target deviating from 2%, the speculation of the Federal Reserve changing the long-term level of neutral interest rate, concerns about the rising liquidity risk under the large-scale issuance of US treasury bond bonds, and concerns about the dominant position of the US finance after Moody's downgraded the US sovereign credit rating were all factors contributing to the rise of the US term premium.
Since December, the rapid decline in US bond rates has been mainly affected by the reduced uncertainty of the Federal Reserve's monetary policy, while the forward expectations for short-term interest rates have also slightly decreased. Since November, the impact of the US debt crisis and government shutdown has gradually diminished, the US fiscal risk has eased, the term premium has fallen, and the US bond yield has also fallen. On December 13th Eastern Time, the Federal Reserve held its December FOMC interest rate meeting. Powell changed his hawkish stance from early December and made it clear that interest rate hikes had basically come to an end, implying that interest rate cuts could start being discussed. The statement by the Federal Reserve in this round has reduced the market's previous divergence regarding the end point of the Fed's interest rate hike cycle, further unifying market expectations. Therefore, the market believes that the uncertainty of the Federal Reserve's monetary policy has significantly decreased, reflected in a significant decline in the MOVE index, which is also the main reason for the recent decline in US bond yields. At the same time, the forward expectations of short-term interest rates have also slightly declined due to dovish statements from Federal Reserve officials. The combined effect of the two has led to a rapid decline in US Treasury yields since December.
Looking back, we believe that the forward expectations for short-term interest rates will significantly decrease, and the premium on US Treasury maturities may slightly increase. The central probability of US Treasury yields in the next year is likely to remain between 3.6% and 4.0%.
The forward expectation of short-term interest rates is still expected to decrease by 80BP-110BP, which may become the main driving force for the decline in US bond yields in 2024. The latest grid chart released by the Federal Reserve shows that FOMC members have a median expectation of 4.6% for policy interest rates in 2024, implying a 75 basis point rate cut next year (corresponding to three rate cuts). According to CME's latest federal funds rate futures target rate, it can be seen that the market believes that by the end of 2024, the Federal Reserve is expected to cut interest rates by 150 basis points (implying 6 rate cuts). Therefore, we can assume that the Federal Reserve will cut interest rates 3-6 times in 2024, corresponding to a decrease in interest rates between 75BP and 150BP. From the changes in previous interest rate reduction cycles, when the federal funds target interest rate falls between 75BP and 150BP, the average forward expected decline in short-term interest rates is between 84BP and 112BP, corresponding to a central decline between 3.170% and 3.457%. This should be the main driving force behind the decline in US bond yields in 2024.
Inflation and monetary policy risks are expected to fall, providing downward momentum for term premiums. According to Bloomberg's consensus forecast, the core PCE in the United States is expected to decline to around 2.5% in December 2024 and around 2.3% in March 2025. At the same time, despite a significant increase in inflation in the United States between 2021 and 2023, inflation expectations remain stable at around 2.5%. Looking back, in the future, as the core PCE of the United States gradually approaches inflation expectations year-on-year, the market will gradually clarify the path of inflation return, and the action path of the Federal Reserve's monetary policy will also become clearer. Inflation and monetary policy risks are expected to decline.
The risk of economic growth will slightly increase in the future, and the rise in the unemployment rate gap will support the term premium. According to predictions from the Congressional Office and the market on the unemployment rate, the unemployment gap in the United States will rise from the current -0.72% to around zero in the next 1-2 years. From the regression equation, the increase in the unemployment rate gap corresponds to an increase of about 15BP in the US term premium, and at the same time, the central point of the US term premium will rebound to around 0.56%.
The premium on US bond maturity may slightly increase, and the forward expectation of short-term interest rates will significantly decrease. The central probability of US bond yields in the next year is likely to remain between 3.6% and 4.0%. Due to the unpredictable impact of credit risk events in the United States, we will only analyze the central point of term premium from two factors: inflation, monetary policy risk, and economic growth risk. In the future, the unemployment rate gap in the United States will rise, but considering the decrease in inflation and monetary policy risks, we expect the center of the term premium to rise to between 0.4% and 0.5%. In addition to the previous estimate of the forward expectation of the US short-term interest rate (between 3.170% and 3.457%), the central probability of the yield of US treasury bond bonds in the next year will remain between 3.57% and 3.96%, and the trend will be higher in the front and lower in the back with the pace of interest rate reduction of the Federal Reserve.
1.2. The possibility of further significant decline in US bond interest rates is limited
Although the 10-year US Treasury yield is likely to continue to decline, the likelihood of a sustained rapid decline is not high. Firstly, the neutral interest rate in the United States is still higher than the current level, and the pace and timing of interest rate cuts may be constrained. Secondly, only after inflation concerns are completely resolved can the Federal Reserve release a clear signal of direction, and there is still a possibility of fluctuations in inflation and monetary policy risks. Third, although the probability of recurrence of government shutdown crisis and credit rating downgrade is not high, the debt burden of the United States is high, and the credit risk of the United States government still deserves attention. The final wave of artificial intelligence may lead to a long-term upward trend in the US interest rate center, as it enhances production efficiency. Therefore, we believe that the sustained decline in US Treasury yields is limited and will not quickly drop below 3%.
The neutral interest rate in the United States is still higher than the current level, and the pace and timing of interest rate cuts may be constrained. Although the likelihood of future Fed rate hikes is low, the US neutral interest rate calculated based on the Taylor rule (extended Taylor rule) is still higher than the current interest rate level. Therefore, if inflation falls below expectations, the actual pace of interest rate cuts by the Federal Reserve may be lower than market expectations, and the magnitude of the expected decline in short-term interest rates may not be as high as previously anticipated.
Oil prices are prone to rise but difficult to fall, and inflation still has the potential to fluctuate. Inflation and monetary policy risks may continue to fluctuate. The subsequent changes in oil prices depend on the evolution of the Israeli Palestinian conflict, the slowing pace of US demand, and the continuity of Saudi Arabia's production reduction policy. According to EIA estimates, global crude oil will continue to maintain a tight supply-demand balance in 2024. Considering that crude oil inventories are at a low level and pricing power remains with OPEC
