Source: CICC fixed income research
Abstract
Since March 2024,HoldempokerrulesThere has been a big increase in the prices of important commodities such as gold, copper, oil and so on.HoldempokerrulesThe underlying factors or market concerns about the weakening of US dollar credit have led to a rise in the prices of dollar-denominated goods, especially those with tight supply. But at the same time, led by artificial intelligence, US stocks are still strong, superimposed fiscal spending is still high, and the US economy still shows resilience and restricts the Fed to turn loose, so gold prices, US debt interest rates and the dollar exchange rate rise together.
The weakening of US dollar credit may be dragged down by the substantial fiscal expansion and monetary overhang of the United States in recent years.
The heavy burden of interest payments in the United States can easily lead to concerns about the decline in the solvency of the United States. After the COVID-19 epidemic, the US government borrowed heavily, and the increase in US debt during the two terms of office of Trump and Biden accounted for more than 40% of all US debt. Superimposed before the Federal Reserve raised interest rates sharply, the U. S. government's interest spending skyrocketed. No matter from the absolute scale, the proportion of fiscal revenue or the comparison with other fiscal expenditure, the current interest expenditure burden of the United States government has been relatively heavy. That could add to concerns about the solvency of US debt, which in turn exacerbates mistrust of the dollar.
Under the environment of heavy borrowing and high interest rates, the "sequelae" of the dual fiscal and trade deficits of the United States have emerged. Double deficits may also exacerbate the decline in dollar credit. With the support of economic, military and scientific and technological forces, funds exported from double deficits can often be returned to the United States through taxes on global profits and capital inflows made by US companies. as a result, the market usually does not doubt the solvency of the United States and the ability to buy dollars. But when inflation causes US interest rates to continue to rise, the US interest burden is getting heavier and heavier, inevitably causing the market to worry about a decline in the solvency of US Treasuries. In particular, overseas investors account for a relatively high proportion of US debt investors, and once overseas investors are worried about the solvency of US Treasuries, they may turn to other alternatives and require US Treasuries to pay higher interest rates to balance future repayment risks. in this case, overseas central banks may gradually increase their holdings of gold and reduce their allocation to US bonds.
Relative changes in the geopolitical environment and the competitiveness of US companies may exacerbate market concerns about US solvency. Recent geopolitical changes and the relative decline in the competitiveness of US companies in the global industrial chain may also be triggers of concerns about the solvency of US Treasuries. Therefore, on the one hand, we see that US stocks continue to hit new highs driven by artificial intelligence, but on the other hand, we also see that gold prices continue to hit record highs to some extent affected by market concerns about the decline in the credit of the US dollar. This is equivalent to the market betting on both trust and mistrust of the United States. However, looking at the lengthening trend, we believe that the impact of the latter may strengthen and further push up the prices of commodities priced in dollars in the short to medium term. This has plunged the United States into a vicious circle of "weakening dollar credit-rising dollar-priced commodity prices-strengthening inflation resilience-maintaining high interest rates on US debt-increasing interest burden on US debt-increasing risk of US debt repayment-weakening of US dollar credit".
Under the background of "three highs", the US economy and stock market may eventually weaken gradually, which may lead to a rate cut by the Federal Reserve and promote the flow of stock market funds to the bond market.
High oil prices, high interest rates and high wages often lead to a contraction in US corporate profits and a decline in the economy and stock market, and we think this may be no exception. Over the next two or three quarters, we believe that the vicious cycle may continue in the short term, which will cool the US economy and stock market again, making it easier for the Fed to start cutting interest rates. At the same time, if the U. S. stock market falls, equity investors may turn to allocate bonds and help push down interest rates on U.S. Treasuries.
Us debt interest rates may rise first and then fall, gold prices may still have room to rise, and risky assets may need to be treated with caution.
Overall, we believe that US bond interest rates may still rise in the short term and gradually fall back in the third quarter, provided there is a relatively significant correction in the stock market. With the current high valuations in US and European stock markets and increased global economic and geopolitical uncertainty, the risk of future stock market adjustment may increase or need to be treated with caution. On the other hand, US Treasuries may wait for interest rates to rise further, especially after a more significant decline in US stocks. After all, the supply of US bonds is still high, so equity investors may need to increase their holdings of bonds to help hold down interest rates. The premise of increasing holdings may be that the fall in the stock market triggers a transfer of demand for asset allocation. In terms of other assets, we are more optimistic about the rising space for gold, and the risk of a decline in US solvency may prompt investors to further increase their holdings of gold. Crude oil, non-ferrous, black and other commodities do not rule out further higher prices in the short term, but considering that higher prices will also inversely dampen demand, the rising space may be relatively limited; at the same time, if demand from the United States and Europe shrinks in the future, it will also lead to a fall in high prices. As for Chinese bonds, at a time when global economic demand is beginning to decline, the risk aversion logic may further depress Chinese bond interest rates, especially if external demand falls, it will also be a drag on the economy to a certain extent. we believe that domestic monetary policy may be further relaxed in the future and domestic bonds can continue to be allocated.
Risk.
Us inflation fell more than expected, and the Fed's monetary policy was looser than expected.
Text
Since March 2024, the prices of gold, copper, oil and other important commodities have risen a lot, which to some extent contributed to the higher-than-expected recovery of CPI in the United States in March. However, we believe that the rise in commodity prices may not be entirely caused by a marked increase in overall industrial demand, nor is it entirely caused by the expectation that the Fed will cut interest rates and bring about liquidity easing. Although some supply disruptions (such as reduced oil production, reduced copper smelting in China, etc.) can be partially explained, they may not be the core reason. Historically, over a long period of time, the price of gold has been negatively correlated with the dollar index, while gold has recently risen sharply while the dollar index is still strong (figure 1). We believe that the underlying factor may be the rise in market mistrust of the dollar itself, which has led to a rise in the prices of goods denominated in dollars, especially those with tight supply. But at the same time, US stocks are still strong driven by artificial intelligence, the intensity of superimposed fiscal spending has not declined significantly, and the US economy still shows resilience and restricts the Fed's turn to looseness. as a result, the price of gold, the interest rate of the US dollar and the exchange rate of the US dollar rose together.
Chart 1: the price of gold has risen in line with the dollar index recently.
Note: data as of March 2024
Source: Bloomberg, China International Capital Corporation Research Department
The weakening of US dollar credit may be dragged down by the substantial fiscal expansion and monetary overhang of the United States in recent years.
The heavy burden of interest payments in the United States can easily lead to worries about the decline in the solvency of the United States.
After the outbreak of COVID-19, the US government continued to issue a large number of bonds to support several rounds of large-scale stimulus packages. Although historically, the United States has often been in a state of fiscal deficit and a small period of fiscal surplus, which has led to a continuous increase in the size of the US national debt (figure 2), the amount of debt borrowed during successive presidents has not been as large as that of the last two (figure 3). As of April 11, 2024, the balance of US Treasuries stood at 34.Holdempokerrules.56 trillion dollars. Among them, the increase in US debt generated during Trump's term of office (January 20, 2017 to January 19, 2021) was 7%.Holdempokerrules$.85 billion, or 22.7% of the current total U.S. Debt balance; Biden's current term (since January 20, 2021) has generated an increase of $6.78 trillion in U.S. debt, accounting for 19.6% of the total U.S. Debt balance, accounting for more than 40% of the U.S. Debt balance.
Figure 2: the balance of US Treasuries
Note: data as of April 10, 2024
Source: iFinD, China International Capital Corporation Research Department
Figure 3: the increase in the balance of US Treasuries over previous terms
Note: previous terms of office are from January 20 to January 19 in the first year, and the current term ends on April 10, 2024. The horizontal coordinate is the first year of the term.
Source: iFinD, China International Capital Corporation Research Department
Superimposed by the Fed's previous sharp and rapid rate hikes, one of the consequences of massive borrowing is a sharp rise in interest payments on US government bonds. In terms of net interest expenditure (all interest payments paid by the government minus interest income on its Treasury holdings), as of March 2024, the cumulative value of the federal government's net interest expenditure for 12 consecutive months has reached an all-time high of $787.3 billion (figure 4). At the same time, the share of interest expenditure in fiscal revenue in the United States has also increased significantly. As of March 2024, the share of net interest expenditure in fiscal revenue in the past 12 months has risen to 17.2%, also at an all-time high (figure 5). In addition, compared with other fiscal expenditure items, the net interest expenditure has exceeded the income security expenditure and approached the defense expenditure in the past 12 months, while the net interest expenditure has even exceeded the defense expenditure in the past three months (figure 6, 7). Economically and legally, the principal of national debt can be borrowed to repay the old, but interest needs to be repaid through fiscal revenue, so there is a theoretical limit. If the growth of fiscal revenue obviously lags behind the growth of interest expenditure, then the pressure on interest expenditure will become greater and greater, and there may even be a Ponzi scheme, while the current growth rate of US fiscal revenue is far less than that of interest expenditure (figure 8). In addition, without taking into account the total interest expenditure deducted by interest income, this value has also risen sharply, and the cumulative total interest expenditure in the past 12 months to March 2024 has risen to $1.02 trillion (figure 9). Over the same period, the United States budget deficit was $1.66 trillion. From a multi-dimensional point of view, the current burden of interest expenditure in the United States is already heavy. That could add to concerns about the solvency of US debt, which in turn exacerbates mistrust of the dollar.
Figure 4: significant increase in net interest expenditure in the United States
Note: data as of March 2024
Source: CEIC, China International Capital Corporation Research Department
Figure 5: us net interest expenditure as a share of fiscal revenue rises to an all-time high
Note: data as of March 2024; net interest expenditure and fiscal revenue are cumulative in the past 12 months
Source: CEIC, China International Capital Corporation Research Department
Figure 6: us fiscal expenditure (cumulative value over the past 12 months)
Note: data as of March 2024
Source: CEIC, China International Capital Corporation Research Department
Chart 7: us fiscal expenditure in March 2024
Figure 8: the growth rate of US fiscal revenue is lower than that of net interest expenditure.
Note: data as of March 2024; net interest expenditure and fiscal revenue growth are calculated using their cumulative values in the past 12 months.
Source: CEIC, China International Capital Corporation Research Department
Figure 9: total interest payments in the United States, excluding interest income deductions, also rose to an all-time high
Note: data as of March 2024
Source: haver, China International Capital Corporation Research Department
Under the environment of heavy borrowing and high interest rates, the "sequelae" of US fiscal and trade deficits appear.
Double deficits may also exacerbate the decline in dollar credit. Generally speaking, a double deficit means that a country needs to borrow to spend, but cannot generate enough profits to repay its debts. Like some Latin American countries, the United States is also a country with perennial "fiscal and trade" double deficits. Historically, some Latin American countries that have experienced double deficits and debt risks have experienced declines in their economies, exchange rates and stock markets:
Mexico
Before 1975, Mexico's overall deficit was small, accounting for less than 2 per cent of GDP most of the time. However, with the significant increase in the country's proven oil reserves, the government has invested heavily in the infrastructure of the oil industry, and the rise in expected oil revenues has led to increased public sector investment in other areas such as health and education. there has been a significant increase in the size of the government deficit (figure 10). While the fiscal deficit has increased significantly, the current account deficit has also increased, from an average of 2.1 per cent of GDP in 1960-1973 to 4.5 per cent in 1975, 5.1 per cent in 1980 and 6.2 per cent in 1981 [1]. At that time, foreign exchange earnings could no longer effectively cover the deficit, and the scale of foreign debt increased accordingly (figure 11). In the early 1980s, oil prices fell and the decline in oil revenues further worsened the public finances, with the basic deficit ratio as high as 7.6 per cent in 1981, when concerns about the sustainability of fiscal policy began to increase. currency devaluation and capital outflows are expected to rise, and external debt can only be obtained in a shorter period of time. At the same time, the process of raising interest rates by the Federal Reserve since the late 1970s also significantly pushed up interest rates, increased the burden of interest payment and refinancing on Mexico's debt, contributed to the devaluation of the peso, and led to a sharp increase in the scale of foreign debt, which jumped from about 20% of GDP to nearly 60% in 1982, while Mexico's (non-gold) foreign exchange reserves fell sharply in the same year (down 80% from the same year last year). Finally, the Mexican government was unable to repay its foreign debt. The debt crisis had to be announced in August that the principal of the debt could not be repaid.
Figure 10: the size of the Mexican government deficit
Note: compared with the total deficit, the primary deficit takes into account oil revenue, so the deficit is smaller; data from Meza, Felipe, The Monetary and Fiscal History of Mexico: 1960-2017 (August 9, 2018). University of Chicago, Becker Friedman Institute for Economics Working Paper No. 2018-64
Source: Meza&Felipe (2018), China International Capital Corporation Research Department
Figure 11: scale of government debt at home and abroad in Mexico
Note: data are from Meza, Felipe, The Monetary and Fiscal History of Mexico: 1960-2017 (August 9, 2018). University of Chicago, Becker Friedman Institute for Economics Working Paper No. 2018-64
Source: Meza&Felipe (2018), China International Capital Corporation Research Department
Brazil
After Mexico announced that it could not repay its debt in 1982, Latin American countries, including Brazil, experienced a serious debt crisis. In 1970, Brazil entered the process of industrialization, and the domestic economic growth rate rose rapidly. In 1976, the GDP growth rate rose to 10%. However, due to the low domestic savings rate and the insufficient scale of corporate investment, Brazil needed to rely on a large amount of borrowing to meet the investment demand. During this period, Brazil's debt increased significantly, and Brazil's foreign debt grew at more than 20% (figure 12). The scale of foreign debt increased from US $6 billion in 1970 to US $55 billion in 1978. The government's fiscal deficit is rising rapidly. In addition, interest payments in Brazil rose with the outbreak of the oil crisis in 1973, when interest rates were raised sharply around the world, and Brazil, as an oil importer, was hit and its trade deficit widened, which rose to US $4.7 billion in 1974 (figure 13). As Brazil's debt grew, the Brazilian government increased the issuance of government bonds to cover the deficit, and with the outbreak of the Latin American debt crisis that began with Mexico, there was a massive outflow of foreign capital, and Brazil's balance of payments fell to-$33.4 billion in 1982 (figure 14). The Brazilian government needs to borrow more to repay its debt, causing hyperinflation. As a result, the Brazilian economy fell into recession. In 1981, Brazil's GDP growth rate dropped to-4.25%. Brazil's broad consumer price index (IPCA) grew by more than 100% year-on-year since 1981 and reached a historical record of 6821% in April 1990. The government has started the process of raising interest rates to combat inflation, which has also led to high interest payments, further exacerbating the risk of national debt. On the whole, due to the perennial foreign borrowing of the Brazilian government, the problem of fiscal deficit has become more serious and the risk level of national debt debt has risen rapidly. at the same time, with fiscal expansion, the country has fallen into high inflation, high interest payments and external shocks, resulting in a large outflow of foreign capital, which has brought about a series of problems such as the devaluation of the Brazilian currency and the economic downturn.
In the 1990s, with a series of reform measures taken by the Brazilian government, the Brazilian economy returned to growth. However, in 1994, the Brazilian government implemented the "real plan" to curb inflation, that is, adopting a high interest rate policy and a "fixed exchange rate system", which once again plunged Brazil into a trade deficit. Brazil's trade balance changed from US $10.4 billion in 1994 to-US $3.4 billion in 1995. At this time, the scale of the Brazilian government's foreign debt continued to rise sharply, and since 1992, the growth rate of Brazil's foreign debt balance has risen rapidly. by the end of 1998, Brazil's foreign debt balance has reached 242 billion US dollars, and the central government's fiscal deficit accounts for about 7 percent of GDP. In 1998, with the Asian financial crisis and the Russian financial crisis, Brazil's financial markets also experienced huge shocks at the same time. The Brazilian government's announcement of the delay in debt repayment undermined market confidence. The growth rate of GDP fell back to around 0%, and the massive withdrawal of foreign investment also consumed a lot of Brazil's foreign exchange reserves. In early 1999, Brazil announced the introduction of a floating exchange rate system and borrowed heavily from international organizations, which caused the Brazilian exchange rate to plummet.
In 2013, Brazil again had a double fiscal and trade deficit. On the one hand, due to the large scale of Brazilian pension expenditure, the government's fiscal deficit has become increasingly serious. In 2014, Brazil's fiscal deficit accounted for about 6% of GDP, and for the first time there was a central government-level budget deficit. In 2016, Brazil's fiscal deficit reached the highest level in nearly 20 years, and the scale of foreign debt further increased. On the other hand, as the global economic recovery slows, commodity prices are under pressure, Brazilian export growth slows, ending a 12-year trade surplus and the current account deficit worsens, falling to minus $110.5 billion in 2014. At that time, Brazil's economic growth slowed to 0.5%, and in the following two years it was negative. The recession aggravated the government's fiscal deficit and led to high inflation and currency depreciation. Brazil's IPCA index rose significantly from 2015 to 10.7% in the first quarter of 2016, the highest level since 2004. In order to curb inflation, domestic benchmark interest rates have risen again, causing household consumption and business investment to fall into the doldrums. At the same time, the United States began to gradually withdraw from the policy of quantitative easing, the global risk appetite declined, and the exchange rate of the US dollar rose, which led to the relative depreciation of the Brazilian currency and the massive outflow of foreign capital, which further had a certain impact on the foreign exchange market and the financial market.
Figure 12: growth of Brazil's external debt balance
Note: data as of 2022
Figure 13: Brazil's trade balance
Note: data as of 2023
Figure 14: Brazil's balance of payments
Note: data as of 2023
Figure 15: Brazil's fiscal deficit as a percentage of GDP
Note: data as of 2022
Figure 16: Brazilian stock market index trend
Argentina
One of the more serious debt crises in Argentina occurred in 2001-2002. Due to long-term high fiscal expenditure, the Argentine government authorities need to continue to increase debt to cover the fiscal deficit, and its limited domestic funds have led to the majority of Argentina's external debt. However, the foreign debt borrowed by Argentina has not been effectively used for economic construction. As its domestic fiscal deficit has intensified, inflation and unemployment remain high, foreign confidence in Argentina has weakened and there has been an outflow, while Argentina is highly dependent on foreign debt. as a result, the outflow of foreign capital has intensified the financing pressure on Argentina. Superimposed by the global economic slowdown, Argentina's trade situation is not optimistic, the economy has fallen sharply. At the end of 2001, the three major international rating agencies downgraded Argentina's international credit rating one after another, which further led to a decline in Argentine bond prices and a rapid rise in financing costs. Finally, as external financing tightened, the Argentine Government faced payment difficulties, declared a default on its debt in late 2001 and abandoned its "convertibility scheme" pegged to the United States dollar in January 2002 (1:1 of the Argentine peso and the United States dollar). The debt crisis has plunged the Argentine economy into chaos, including a sharp devaluation of the currency (figure 19), high inflation and recession.
Figure 17: Argentina's fiscal deficit as a share of GDP
Note: data as of 2023
Source: haver, China International Capital Corporation Research Department
Chart 18: Argentina's current account balance as a proportion of GDP
Note: data as of 2023
Source: haver, China International Capital Corporation Research Department
Chart 19: after abandoning the convertibility program in 2002, the Argentine peso depreciated sharply
Chart 20: Argentine stock index fell in 2001
The United States itself is also in a state of double deficit all the year round (figure 21), but unlike the above-mentioned Latin American countries, with the support of economic, military, scientific and technological forces, American companies can get rich returns around the world. and sent back to the US government through taxes. At the same time, it can also balance the negative impact of double deficits through strong capital inflows. In other words, although the United States is also in a state of double deficit, the United States has a "replenishment" mechanism, which means that the funds exported from the double deficit can be returned to the United States, thus balancing exchange rate pressure and financial pressure. Therefore, when the US economy, military and science and technology are strong enough, the market generally will not doubt the debt repayment ability of the United States and the purchasing ability of the US dollar. This may also be the reason why the depreciation of the US dollar is more reflected in the depreciation of commodities than against other currencies, that is, the so-called inflation, after the large amount of QE and fiscal expansion in the United States after the epidemic.
Chart 21: the United States is in a perennial state of double deficit
Note: data as of 2023
Source: iFinD, China International Capital Corporation Research Department
Figure 22: the depreciation of the dollar may be more reflected in the depreciation of commodities.
Note: the dollar index is the monthly average, as of April 11, 2024, and CPI as of March 2024.
Source: iFinD, China International Capital Corporation Research Department
When inflation brings about a sustained rise in US interest rates, a more obvious "sequela" begins to emerge, that is, the increasing interest burden on US finance. And when the interest burden continues to rise rapidly, the market will inevitably start to worry about the solvency of US Treasuries. After all, US treasury bonds are different from Japanese treasury bonds, most of which are held by domestic financial institutions and held by foreign investors, and the interest rate of Japanese treasury bonds is very low, so although the proportion of Japanese treasury bonds in GDP is significantly higher than that of the United States, the current pressure on the repayment of principal and interest on Japanese debt may not be as high as that of the United States. A high proportion of US Treasuries are held by foreign investors (figure). As of January 2024, foreign investors held US $8.02 trillion, accounting for 23.5 per cent of total US debt and 29.6 per cent of US debt held by the public (figure 23). Not only that, many central banks use US Treasuries as reserve assets, and once foreign investors worry about the solvency of US Treasuries, they may turn to other alternatives and require US Treasuries to pay higher interest rates to balance future repayment risks. in this case, overseas central banks may gradually increase their holdings of gold and reduce their allocation to US bonds.
Figure 23: proportion of overseas investors in US Treasuries
Note: data as of January 2024
Source: iFinD, China International Capital Corporation Research Department
From our observation, the scale of gold held by global central banks has increased significantly since 2022 (figure 24). The people's Bank of China is an important force in gold demand, accounting for 43% of the increase in gold holdings by global central banks since 2022H2, and the proportion of gold in foreign exchange reserves has further risen to an all-time high of about 4.3%, but it is still far lower than economies such as the United States, the euro zone, the United Kingdom and India. There is room for further improvement. In addition, the central banks of Turkey and Poland are also the main buyers. It is worth noting that there has also been a significant increase in global central bank gold purchases between 2018 and 2019, and the overall scale is higher than the current level, but at that time, the sharp increase in central bank gold holdings was mainly driven by Central and Eastern Europe, 2018H2 to 2019H1, global central bank gold reserves increased by 718 tons, of which Russia accounted for nearly 40%, Russia, Poland and Turkey accounted for more than 60%, and other central banks bought relatively small amounts of gold. This time, the people's Bank of China is more involved, and the economies that increase their gold holdings are relatively more diversified. So the recent rise in gold prices can be understood to a large extent as concerns about the solvency of US Treasuries and a decline in confidence in the dollar itself. In fact, the size of global gold ETF (in terms of physical gold) has been in a state of net decline for most of the first half of 2021 and remains so against the backdrop of rising gold prices in 2023 (figure 26), reflecting that the previous rise in gold prices may not have been driven by traditional allocation forces, but is more likely to be increased holdings by global central banks and by trading investors such as hedge funds in this context.
Figure 24: changes in gold holdings by regional central banks (semi-annual)
Note: data as of December 2023
Source: world Gold Council, China International Capital Corporation Research Department
Chart 25: total changes in gold holdings by regional central banks from January to February over the years
Note: data as of February 2024
Source: world Gold Council, China International Capital Corporation Research Department
Figure 26: net increase in global gold ETF size (in terms of physical gold held)
Note: the data frequency is half-yearly, and the data of 2024H1 as of March 2024
Source: world Gold Council, China International Capital Corporation Research Department
Figure 27: cumulative changes in gold price and gold ETF scale
Note: data as of March 2024
Source: world Gold Council, China International Capital Corporation Research Department
Relative changes in the geopolitical environment and the competitiveness of US companies may exacerbate market concerns about US solvency
In addition, recent geopolitical changes and the relative decline in the competitiveness of US companies in the global industrial chain may also be triggers of concerns about the solvency of US Treasuries. In the field of new energy vehicles, for example, Chinese automakers have become more competitive, while Apple has abandoned its car-building plans, and Tesla's sales have begun to decline, causing its share price to fall. These events have partly led investors to focus on whether the ability of US companies and the US government to make profits in global markets is beginning to decline, and then worry about whether it may make it more difficult to repay debt in the future.
Therefore, on the one hand, we see that the US stock market has continued to hit new highs since last year, or it reflects the market's trust in the technological revolution of artificial intelligence in the United States, but on the other hand, we also see that the price of gold continues to hit record highs. This may reflect the market's mistrust that the United States continues to rely on debt expansion to drive its economy but is faced with the current debt-driven model. This is equivalent to the market betting on both trust and mistrust, which is why liquidity has not eased significantly this time, but it has also seen a rise in risky assets and safe-haven assets at the same time (figure 28).
Figure 28: recent rise in risky assets and gold
Note: data as of March 2024
Source: Bloomberg, China International Capital Corporation Research Department
However, looking at the lengthening trend, we believe that mistrust of the US debt-driven model may further push up the prices of commodities priced in US dollars in the short to medium term, and the prices of important goods such as gold, oil and copper may also rise. this may increase the resilience of US inflation and make it more difficult for the Federal Reserve to cut interest rates, which may lead to higher US interest rates and continue to increase the debt burden of the United States. This in turn exacerbates concerns about the solvency of US debt and mistrust of the US dollar, which in turn further pushes up commodity prices, that is, falling into a vicious circle of "weakening US dollar credit-rising commodity prices priced in dollars-stronger inflation resilience, keeping interest rates high on US debt-increasing interest burden on US debt-increasing risk of US debt repayment-weakening US dollar credit".
Under the background of "three highs", the US economy and stock market may eventually weaken gradually, which may lead to a rate cut by the Federal Reserve and promote the flow of stock market funds to the bond market.
Historically, high oil prices, high interest rates and high wages have often led to a contraction in American corporate profits. after all, the "three highs" mean higher costs for enterprises. Therefore, in the "three highs" environment, the US economy and stock market tend to decline, and this may be the same situation.
As we mentioned in "the game between supply and demand of US debt and inflation continues, interest rates rise in the short term and fall in the long term", historically, high oil prices, high interest rates and high wages often lead to a contraction in US corporate profits. On the one hand, high interest rates and high oil prices will restrain corporate investment and physical demand to a certain extent, on the other hand, the rise in wage expenditure and financing interest rates will also lead to an upward trend in corporate costs, which will eventually put pressure on its profitability. For example, in 2018, in the context of a significant tightening of US monetary policy, US Treasury interest rates rose sharply, while international oil prices climbed to a higher level due to geopolitical factors, and non-farm wage growth also increased at that time. In the "three highs" environment, corporate revenues are under pressure, financing costs are rising, and the EPS of S & P 500 companies has fallen sharply from a year earlier (figure 30). Similarly, in 2022, the "three highs" situation reappeared, corporate profits were damaged again, and EPS declined compared with the same period last year. In addition, there was a similar environment around 2000 and around 2007, when corporate profits also fell significantly, of course, when the bursting of the bubble after the over-booming stock market had a greater impact on the economy and EPS. Therefore, in the "three high" environment, the US economy and stock market tend to decline, although the erosion of corporate profits may be relatively limited for the time being, but over time, the impact of these factors on the economy may be apparent.
Figure 29: oil prices, US Treasury interest rates and non-farm wage growth
Note: data as of March 2024
Source: Wind, China International Capital Corporation Research Department
Figure 30: EPS of the S & P 500
Note: data as of March 2024
Source: Bloomberg, China International Capital Corporation Research Department
Therefore, in the next two or three quarters, we think that in the end, distrust of the American model will overwhelm trust in the advantages of artificial intelligence, which in turn will cause the US economy and stock market to cool again, eventually leading to a fall in corporate profits, demand and prices. In this case, it is more likely to see the Fed start to cut interest rates. In other words, the vicious circle may continue in the short term, and US inflation and interest rates may rise in the short term, forcing the US economy and stock market to cool down. If the US stock market falls, equity investors could turn to allocating bonds and help drive down interest rates on US Treasuries.
Us debt interest rates may rise first and then fall, gold prices may still have room to rise, and risky assets may need to be treated with caution.
Overall, we believe that US bond interest rates may rise further in the short term and may gradually fall back again at the beginning of the third quarter, provided there is a relatively significant correction in the stock market. At present, the valuations of US and European stock markets are on the high side, the global economic and geopolitical uncertainty increases, and the risk of future stock market adjustment may increase, so it is not recommended to continue to add, or even consider reducing holdings. On the other hand, US Treasuries may be allocated gradually after a further rise in interest rates, especially after a relatively obvious decline in US stocks. After all, the supply of US Treasuries is still high this year, and bond investors alone may not be able to hold down interest rates. Therefore, equity investors may also be required to increase their holdings of bonds, and the premise of increasing holdings may be that the decline in the stock market in the United States and Europe triggers the transfer of demand for asset allocation.
In terms of other large categories of assets, we are still optimistic about the rising space for gold. After all, if there is a risk of a decline in the solvency of the United States, then the allocation value of US Treasuries as foreign exchange reserves may decline. In turn, global central banks and residents may further increase their holdings of gold. At the same time, due to the small use of the gold industry, even if the price rises more, it will not cause social conflicts, and it will not affect the production of enterprises and the lives of residents because of the rise too much, so there is a lot of room for imagination about the rising rate of gold. While commodities for industrial use, such as crude oil, non-ferrous, black and other commodities, do not rule out further higher prices (including geopolitical uncertainty) in the short term, but considering that higher prices will also inversely dampen demand, the room for rise may be relatively limited, and if demand from the United States and Europe shrinks in the future, commodity prices for industrial use may eventually fall back high. As for Chinese bonds, in the context of the decline in global economic demand, although there are some recent transmission pressures of rising global prices, the risk aversion logic may also further depress Chinese bond interest rates. in particular, if external demand falls, it will also have a certain impact on the economy at the macro level. We believe that domestic monetary policy may be further relaxed in the future and domestic bonds can continue to be allocated.
Chart 31:S&P500 forward PE
Note: as of April 10, 2024
Source: Reuters, China International Capital Corporation Research Department
Chart 32:Bloomberg US Financial conditions Index
Note: as of April 10, 2024; a high value means looser.
Source: Bloomberg, China International Capital Corporation Research Department