How to view US bond interest rates? - Haitong's Macro Outlook for 2025 Part 3

Investment Highlights The U.S. Treasury bond rate, as an important foundation for pricing various assets globally, is crucial for global asset allocation decisions. The fluctuation of the U.S. Treasury bond rate in 2024 has caused significant disturbances in global assets. This article aims to analyze the key DRIVE of the U.S. Treasury bond rate trend since the beginning of this year by breaking down the U.S. Treasury bond rate and further forecast the trend of the U.S. Treasury bond rate in 2025 through model analysis. 1. U.S. Treasury bond rates: Increased volatility In 2024, the U.S. Treasury bond rates continued to exhibit a high degree of volatility. Since the beginning of the year, U.S. Treasury bond rates have been on an upward trend, especially for the 3-year, 5-year, 7-year, and 10-year Treasury bonds, with larger increases in the medium to long-term bonds. From the beginning of the year to the end of April, the increase in rates exceeded 80 basis points. From the end of April, U.S. Treasury bond rates started to trend downward, especially for the 2-year and 5-year bonds, with a significant decrease from the end of April to mid-September, exceeding 140 basis points. The 10-year Treasury bond rate also decreased by over 100 basis points, while the 5-year and 7-year bond rates decreased by over 120 basis points. Starting from mid-September, U.S. Treasury bond rates started to rise again, with the medium to long-term bonds showing a larger increase. From mid-September to mid-November, the rates for 3-year to 10-year Treasury bonds all increased by over 80 basis points. From mid-November to early December, U.S. Treasury bond rates decreased again, with the long-term bonds decreasing by nearly 30 basis points from the 5-year to the 30-year period. By the week ending December 13, there was a rebound in U.S. Treasury bond rates. From the perspective of U.S. Treasury bond rate volatility, it follows a similar pattern. According to the U.S. Federal Reserve's volatility index for U.S. Treasury bonds, periods of high volatility often occur during economic downturns, such as the dot-com bubble crisis in 2001, the subprime mortgage crisis in 2008, and the COVID-19 crisis in 2020. Starting from July this year, U.S. Treasury bond volatility has also increased significantly, higher than the average level of the past year, and has...Inflation expectations have surged again. Especially after Trump announced his victory in November, the 10-year inflation expectations in the United States temporarily reached 2.35%. (See report: "US Election Results: What Impact?")From the perspective of the supply and demand of U.S. Treasury bonds, after the short-term supply shock caused by the completion of the U.S. debt ceiling agreement in June 2023, the net supply trend of U.S. Treasury bonds has been relatively flat. Although there has been an increase in net supply of U.S. Treasury bonds since the second quarter, there has also been a noticeable increase in net demand for U.S. Treasury bonds, such as the narrowing of the net reduction by the Federal Reserve and the continuous increase in net purchases by foreign investors. Overall, the supply and demand of U.S. Treasury bonds has been relatively balanced this year, with a relatively small impact on the actual interest rates of U.S. Treasury bonds. Interest rate decomposition two: Short-term interest rates + term premium The above decomposition method is more skewed towards a long-term perspective. In order to further analyze the impact of short-term trading, we will consider the term premium and analyze the factors influencing the changes in long-term interest rates from a more trading and term structure perspective. The term premium refers to the additional compensation that long-term bond holders demand for bearing the risks of real interest rates and inflation risks, including real term premium and inflation risk premium. Therefore, the nominal long-term interest rate can be decomposed into expected future short-term interest rates + term premium = expected future real short-term interest rates + short-term inflation expectations + term premium = expected future real short-term interest rates + short-term inflation expectations + real term premium + inflation risk premium. Through this decomposition method, we found that the high volatility of long-term U.S. Treasury bond rates since the beginning of this year is mainly driven by the actual interest rates of U.S. Treasury bonds, but the main factors driving the different stages are slightly different. Calculations show that from the beginning of the year to the end of April, the significant increase in U.S. Treasury bond... In the past, there have been continuous historical highs. In recent years, the increase in net assets of American households has mainly come from contributions from stocks and real estate. Among them, the proportion of directly held stock assets by households is about 28%; the proportion of holding real estate assets exceeds 26%, with the two totaling over 50%.From the perspective of household debt, as of the second quarter, over 70% of American residents' household debt is comprised of mortgage loans. Among them, the proportion of mortgage loans with high credit quality has always been above 60%, with little default risk. In addition, the proportion of American household mortgage interest expenditure to disposable income is only 5.9%, similar to before the epidemic (March 2020). Furthermore, considering the proactive tax reduction policies that may be implemented by Trump after taking office, this will help with the recovery and stabilization of the economy. We expect that the risk of a significant slowdown in the US economy next year may not be significant. Regarding inflation, there is considerable uncertainty. From the perspective of core inflation, the recent slow decline in core inflation in the United States is largely related to the still high level of rent inflation. With the expected slowing down of future house price growth, US rent inflation is expected to continue to slow down in the first half of next year, which will help alleviate core inflation. However, there is a risk of inflation increase in the second half of the year. In addition, if Trump takes strict policies on tariff increases and immigration control after taking office, this could potentially increase inflationary pressures in the US. We expect that inflation in the US may continue to decline in the first half of next year, but there could be a significant risk of increase in the second half of the year. In terms of monetary policy, the pace of interest rate cuts may slow down. Considering the relatively stable US economy, the job market has not deteriorated significantly, and core inflation has faced resistance in declining, the attitude of the Fed's monetary policy has slightly changed. Following the sharp 50 basis point cut in September, the Fed has continuously emphasized the significant inflation pressures, emphasizing that the Fed's task is to maintain a balance between employment and prices. In addition, the policies implemented by Trump after taking office could increase the risk of inflation increase. We expect that the Fed will most likely continue with interest rate cuts next year, but the pace will significantly slow down or even temporarily pause. Furthermore, at the beginning of next year, the US debt ceiling will expire, which may also have some disturbance on US bond rates. If a new agreement can be successfully reached before the expiration date of the US debt ceiling, the impact on US bond rates may be relatively small. Otherwise, it may lead to a significant increase in the actual term premium of US bonds, pushing up the nominal interest rate of US bonds. Taking all of the above into consideration, based on the ARDL model, we predict that in a neutral scenario, the US economy will be stable, with slowing down inflation, the Fed rate cuts next year will be in line with market expectations, and the range of nominal interest rates on 10-year US bonds may be between 4.0% - 4.5%. In a positive scenario, the US economy continues to decline, inflation accelerates, the Fed's rate cuts next year exceed expectations, and the range of nominal interest rates on 10-year US bonds may be between 3.5% - 4.0%. In a pessimistic scenario, the US economy stabilizes and rebound, core inflation rises, the Fed cuts interest rates less next year, and even does not cut rates, the range of nominal interest rates on 10-year US bonds may be between 4.5% - 5.5%. Risk Warning: US economic performance exceeds expectations, Fed monetary policy exceeds expectations, model prediction errors. This article is from the WeChat public account "HT Macro Research", written by analysts Liang Zhonghua and Li Jun; GMTEight editor: Wen Wen.