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Impact of the US Government Debt Problem on Economic Expectations - Huxiu.com#
Omnivore#
Highlights#
- Dot plot; 2. S&P 500.
These two represent the expectations of the Federal Reserve for the US economy and the expectations of the capital market for the US economy. ⤴️ ^1d606436
The dot plot reflects the Federal Reserve's expectations for the US economy
The S&P 500 reflects the capital market's expectations for the US economy
But I haven't figured out what the dot plot is yet.
According to our comparison table, it is not difficult to find that the dot plot believes that interest rates will not be lowered until November next year, but the market believes that interest rates will be lowered in September next year; the dot plot believes that interest rates will be lowered twice next year, while the market believes that interest rates will be lowered three times.
The market has begun to strongly question the Federal Reserve. ⤴️ ^9b9cf404
The current situation is that the market, or capital, strongly doubts the Federal Reserve's expectations for the future of the US economy.
If we ignore the credit factors implied by long-term US bonds, we would naturally think that risk-free interest rates have also soared. ⤴️ ^0d4c66ea
On the one hand, as the risk of US government debt increases, the impact of credit factors expands, leading to an increase in the yield of 10-year US bonds.
On the other hand, as the risk of US government debt increases, economic risks also increase, so risk-free interest rates should decline, leading to a decline in the yield of 2-year US bonds.
Therefore, we can draw an interesting conclusion that the risk of US government debt will push the term spread wider.
In fact, as the US government's debt problem becomes more severe, the market is more willing to chase risk-free assets and chase short-term US bonds.
In fact, the logic behind the funding is also simple. The more severe the US government's debt problem, the more intense the selling of long-term bonds and stocks, and the more funds will be hidden in short-term bonds. The economic prospects implied by short-term bonds will be more pessimistic, and the Federal Reserve will have no way to hide.
Impact of the US Government Debt Problem on Economic Expectations#
I. Adjustment of Economic Expectations
The US government's debt problem has become a gray rhino, constantly stirring the nerves of the capital market. Currently, the capital market has begun to revise down its expectations for the US economy.
On September 26, 2023, the S&P 500 index continued to plummet by 1.47%, and the stock market has clearly expressed its concerns.
In the article "How to Track US Monetary Policy and Economic Expectations?" we discussed before, we have discussed that 2-year US bonds integrate two factors: 1. Dot plot; 2. S&P 500.
These two represent the expectations of the Federal Reserve for the US economy and the expectations of the capital market for the US economy.
Last night, the US stock market made a significant adjustment. Theoretically, the yield of 2-year US bonds should also decline. Strangely, when the US stock market fell, the yield of 2-year US bonds remained unchanged. It was not until the Asia-Pacific trading hours that the yield of 2-year US bonds dropped significantly to around 5.07%.
According to our comparison table, it is not difficult to find that the dot plot believes that interest rates will not be lowered until November next year, but the market believes that interest rates will be lowered in September next year; the dot plot believes that interest rates will be lowered twice next year, while the market believes that interest rates will be lowered three times.
The market has begun to strongly question the Federal Reserve.
As shown in the following chart, as long as the S&P 500 index continues to fall, the green area will continue to expand until the Federal Reserve surrenders.
The above is the story of economic expectations. The market is constantly pulling and tugging with the Federal Reserve, and the yield of 2-year US bonds well demonstrates this process.
The credit premium implied by 10-year US bonds
At this point, someone may ask, since the market is revising down its expectations for the US economy, why is the yield of 10-year US bonds rising? Why is there no seesaw effect between 10-year US bonds and US stocks? This is because sometimes 10-year US bonds do not represent risk-free interest rates, especially when there are problems with US debt.
As shown in the above chart, when the US government's debt problem starts to cause trouble, gold represents risk-free interest rates, 3-month US bonds represent risk-free interest rates, and even 2-year US bonds can represent risk-free interest rates, but long-term US bonds imply credit factors.
The reason why we easily confuse the interest rate increase caused by credit factors is that we like to express the price of bonds in the form of a fixed numerator. If we convert it into a variable numerator, the situation becomes clear: risk-free interest rates may not change much, but credit factors bring huge fluctuations.
If we ignore the credit factors implied by long-term US bonds, we would naturally think that risk-free interest rates have also soared.
The US dollar is the world's dollar, and US bonds are the US government's debt.
Impact of credit crisis on risk-free interest rates
In fact, the relationship between credit factors and risk-free interest rates is not independent. Rising credit risks will suppress risk-free interest rates.
For example, the domestic Baoshang Bank incident and the Yongmei Holdings incident have both lowered risk-free interest rates; the Silicon Valley Bank incident in the United States has also lowered risk-free interest rates. Logically, when the US government has debt problems, risk-free interest rates should also decline. However, we can no longer use 10-year US bonds to represent risk-free interest rates, at most, we can use 2-year US bonds.
As shown in the above chart, the price of 10-year US bonds implies credit factors, that is, the risk of US government debt. For convenience of presentation, we put the credit factor in the numerator.
On the one hand, as the risk of US government debt increases, the impact of credit factors expands, leading to an increase in the yield of 10-year US bonds.
On the other hand, as the risk of US government debt increases, economic risks also increase, so risk-free interest rates should decline, leading to a decline in the yield of 2-year US bonds.
Therefore, we can draw an interesting conclusion that the risk of US government debt will push the term spread wider.
Don't talk about inflation anymore, it has nothing to do with inflation.
Economic expectations implied by bonds of different maturities
In fact, the more severe the US government's debt problem, the more the market is willing to chase risk-free assets and chase short-term US bonds.
To be honest, the view expressed by 2-year US bonds is already modest. It predicts that interest rates will be lowered 3 times next year.
However, 1-year US bonds, which have fallen to 5.44%, express even more unrestrained expectations. It believes that the Federal Reserve will lower interest rates 6 times next year, and the earliest rate cut will be in May next year.
In fact, the funding logic behind it is also simple. The more severe the US government's debt problem, the more intense the selling of long-term bonds and stocks, and the more funds will be hidden in short-term bonds. The economic prospects implied by short-term bonds will be more pessimistic, and the Federal Reserve will have no way to hide.
Conclusion
To sum up, we have clarified the impact of the US government's debt problem on expectations for the US economy:
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The US government's debt problem has a negative impact on expectations for the US economy;
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This impact is mainly reflected in the US stock market and US short-term bonds;
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The impact of long-term US bonds is unclear because they imply credit factors, and interest rates can either rise due to credit factors or fall due to risk-free interest rates;
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The risk of US government debt will definitely push up the term spread in the US.
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