Huachuang Securities: U.S. bond yields rise, inflation or deficit narrative.

Huachuang Securities released a research report stating that the contribution of inflation expectations and inflation risks to the upward movement of US bond yields is less than the actual term premium, with the main factor of the term premium being the supply and demand of US bonds. In Trump's policies, the most direct impact on the supply and demand of US bonds is the deficit caused by tax cuts. In other words, the "second inflation narrative" may not be the main reason for the rise in US bond yields, but rather the "deficit narrative." The certainty and sustainability of the "deficit narrative" may be higher than the "second inflation narrative." If US bond yields are priced based on the former, then the foundation for the "high for longer" interest rate outlook will be more solid. In October, US CPI inflation completely met market expectations. The CPI year-on-year rose from 2.4% to 2.6%, as expected, 2.6%; and the core CPI remained at 3.3%, as expected, 3.3%. The CPI month-on-month was 0.2%, and the core CPI month-on-month was 0.3%, consistent with the previous month and expectations. With the rise in the year-on-year reading, the breadth of CPI inflation rebounded. Looking at the month-on-month structure in detail: 1) Food prices fell. 2) International oil price adjustments led to a slight drop in gasoline prices, while electricity prices increased, and energy prices transitioned from a decline to stabilization (0%, previously -1.9%). 3) Core CPI month-on-month continued to stabilize at 0.3%, showing stickiness. Among them, core commodity prices stabilized after rising, decreasing from 0.2% to 0%, returning to the historical average, with clothing prices falling, and education and communication prices contributing to the decline, while the increase in used cars expanded (2.7%, previously 0.3%). Rent growth rebounded from 0.2% to 0.4%, with the main contributions being owner's equivalent rent (0.4%, previously 0.3%) and hotel accommodation (0.4%, previously -1.9%). Super core service prices fell from 0.4% to 0.31%. The price increases in transport services, healthcare services, and public utility services, as well as entertainment services (0.7%, previously -0.5%) and other personal services, were the two major drivers. There is a high possibility of another rate cut in December, with a projected 25 basis points. On the one hand, the inflation trend still mainly aligns with the Federal Reserve's expectations. In the short term, due to base effects and inflation stickiness, CPI year-on-year is expected to rebound in the fourth quarter, with core CPI year-on-year expected to hover around 3.3%, reflecting the fluctuation of the de-inflation process, which the Fed may already anticipate (as indicated by the change in the November FOMC statement). Before the data was released, Minneapolis Fed President Kashkari stated that only if inflation surpasses expectations in November and December would they consider pausing the rate cuts. On the other hand, since there was no unexpected rise in inflation in the short term, and considering the dual mandate risks favor employment, and current employment risks are still biased towards downturn, the Fed may continue to cut rates to support the labor market. After the release of the completely expected CPI data, the expectation of a rate cut in December increased. The federal funds market priced the probability of a 25 basis point rate cut in December rising from 58.7% to 82.5%, with the probability of no rate cut falling from 41.3% to 17.5%. US bond yields rose, but what is pricing in? The CPI completely met expectations, coupled with the increasing expectation of a rate cut in December, the ten-year US bond yield continued to rise by about 1.9 basis points. In the past two months, the US bond yield has increased by about 83 basis points, rising from 3.62% on September 16 to the current 4.45%. Most views believe that the main driving force behind the rise in US bond yields is the potential secondary inflation risk narrative triggered by Trump's policies, but the increase in the market's trading inflation expectations has been significantly lower than that of US bond yields. From September 16 to now, the ten-year break-even inflation rate has increased by about 27 basis points, and the 5Y5Y inflation expectation swap has increased by about 18 basis points. In addition, the Federal Reserve's DKW model shows that the contribution of the actual term premium to the increase in US bond yields is greater. From September 16 to October 31 (the latest data), the ten-year US bond yield increased by about 68 basis points, with the actual term premium contributing around 32 basis points, the inflation risk and inflation risk premium compensation combined contributing around 21 basis points, and the real interest rate increasing contributing around 14 basis points. The increased revenue from Trump's tariff policies is not enough to offset the revenue shortfall from massive tax cuts, leading to the rise in deficits and federal debt being a more likely event. Although intuitively, Trump's tariff, tax, and immigration policies have a strong risk of upward inflation, his policies may also bring downward inflation risks: 1) Pressure of lower oil prices. Trump's efforts to suppress oil prices may lead to a significant decline in energy inflation. 2) A comprehensive trade war leading to dim global trade and growth prospects, which, from the demand side, puts downward pressure on inflation. 3) Defeating inflation is Trump's core promise, ranking first in the 2024 campaign agenda. Risk warning: Unexpected US inflation and labor market conditions; Uncertainty in Trump's policies.