December ninth, two thousand twenty-four to December twelfth, two thousand twenty-four

I. Foundation 

resistance to change and hence greater dependability for the results shown in the past.

Can tariffs serve as both a political tool and an economic tool?

A key question for next year is whether tariffs can serve as both a political tool and an economic tool.

Supporters of U.S. tariff policy have long argued that tariffs are versatile tools for achieving economic and political objectives. However, a closer analysis of these objectives and the logic behind them makes it clear that the actual effects of tariff policy often differ significantly from the expected outcomes and may even involve deep-seated contradictions.

The first economic objective of tariffs is to protect domestic industry from “unfair competition” from abroad.

Supporters argue that foreign companies gain a competitive advantage from lower labor costs and state support, and that tariffs can offset this advantage by raising the cost of imported goods.However, research by the New York Fed reveals a very different reality.

The study found that those U.S. companies theoretically positioned to benefit from import protection instead experienced a significant decline in market capitalization on the day tariff policies were announced and subsequently performed poorly on key indicators such as profits, employment, sales, and labor productivity.

This suggests that tariffs may have failed to effectively protect the targeted industries and instead triggered market uncertainty and cost pass-through, ultimately weakening companies’ competitiveness. For investors, this “valuation shock” is one of the major risks on the day tariffs are announced, especially in manufacturing and consumer goods, which are highly sensitive to trade policy.

The second economic objective is to reduce the trade deficit by adjusting the relative prices of goods.

In theory, tariffs raise the prices of imported goods and encourage domestic substitute production, thereby balancing trade. However, the effectiveness of this mechanism depends on the adaptability of domestic supply chains and consumers’ sensitivity to price changes.

In the U.S. consumer goods market, many product categories, such as electronics, clothing, and auto parts, rely heavily on imports, while domestic substitutes cannot quickly fill the gap in the short term.

Tariffs may therefore improve the trade deficit in the data, but in practice consumers bear greater cost pressures. This deserves particular attention amid persistently high inflation: tariff policy could push core inflation higher still and trigger a chain reaction in market expectations.

From a political perspective, tariffs are viewed as leverage to compel trading partners to adopt policies that align with U.S. interests.

This strategy was especially prominent during the Trump administration. Its central logic was to use the size of the U.S. market to make countries dependent on exports to the United States compromise in the face of tariff costs.

The sustainability of this logic is being questioned because the political effectiveness of tariffs depends heavily on the United States maintaining large-scale imports and a trade deficit. If total imports decline, the influence of tariffs over trading partners will gradually weaken.

For example, U.S. imports from Russia have fallen to about 10% of their peak in 2022 3, and the bilateral trade deficit has almost disappeared. In In this situation, tariffs are far less important to U.S.–Russia relations, showing that their leverage weakens substantially when trade volumes are sufficiently small.

The long-term effectiveness of tariffs as a policy tool is also constrained by changes in the international economic system.

Some argue that tariffs may be a more sustainable tool of international influence than economic sanctions (sanctions).The effectiveness of sanctions depends to a large extent on the U.S. dollar’s dominance in the global economy, and this position is not unassailable forever. Although discussion of “de-dollarization” has picked up in recent years, the dollar still has no viable competitor as the global reserve currency.

This means tariffs remain a policy tool the U.S. government can rely on in the short term. Over the longer term, however, whether their leverage effect can persist as global supply chains are reshaped and trade patterns diversify remains to be seen.Implementation could trigger significant market volatility in the short term, particularly among valuation-sensitive industries and companies that rely heavily on imports.

2024.12.10

After 14 years, what changed in the market following the “moderately accommodative” monetary policy at the time

The phrase “moderately accommodative” has reappeared in monetary policy after fourteen years, marking a major shift in the policy environment. The last similar wording appeared during the global financial crisis of 2008 (GFC), when China implemented a “4-trillion” fiscal stimulus plan and injected liquidity into the economy through substantial reserve-requirement and interest-rate cuts, along with other policy tools. This historical background offers a framework for considering the current policy shift.

Chart: Performance of Chinese assets during the “moderately accommodative” monetary policy period in 2008-2011

What happened in 2008?

Looking back at 2008, China cut its reserve requirement ratio (RRR) by 200 basis points in just three months, from 17.5% to 15.5%, and lowered the lending rate from 7.47% to 5.31%.

The 10-year government bond yield quickly fell from 4.5% to 2.7%, while short-term yields fell even further, from 3.6% all the way to 1%, driven by abundant liquidity. Meanwhile, the Shanghai Composite Index (SHCOMP) plunged 30% early in the crisis, but thanks to powerful fiscal stimulus, the market subsequently bottomed out and rebounded and doubled in less than a year.

On the exchange-rate front, The renminbi stopped appreciating and was pegged to the U.S. dollar in the second half of 2008, and only resumed a gradual appreciation in 2010.

These policy combinations clearly show China’s objectives at the time:quickly stabilize liquidity through monetary easing, stimulate domestic demand through fiscal stimulus, and ensure financial-market stability. The current call for a “moderately accommodative” monetary policy clearly draws on this model.

Chart: History of China’s macro policy stance

What might this new “moderately accommodative” stance bring?

Reintroducing the “moderately accommodative” stance will have far-reaching effects on bond, equity, and foreign-exchange markets. First, The bond market’s pricing logic will inevitably need to be reassessed. When monetary policy shifts toward easing, interest-rate declines are usually front-loaded. The previously expected room for Chinese interest rates to fall by 40 -50 basis points in 2025 may be realized more quickly over the coming quarters as policy turns earlier.

The likelihood of a substantial reserve-requirement ratio cut by the central bank has risen significantly. Governor Pan Gongsheng had previously signaled a 50-basis-point cut, which May become the first step in subsequent policy. In addition, the use of unconventional tools such as open-market operations and direct purchases of government bonds (CGB) may expand, injecting medium- to long-term liquidity into the market.

It should be noted that the full effects of the current policy mix remain to be seen, Monetary easing will benefit the bond market in the short term, but once the details of fiscal stimulus become clear, long-term rates may come under pressure again, bringing the risk of a steeper yield curve.Especially If the scale of fiscal policy exceeds expectations, a rise in government bond yields similar to that of 2008 may recur.

Chart: Goldman Sachs expects China’s easing policies to continue through 2025 or even longer

On equities and foreign exchange

Underweight positioning in Chinese assets has returned to its previous trading range, especially among offshore investors. If the improvement in risk appetite following the policy shift is gradually confirmed, it will certainly drive further foreign inflows, but this is a process, not an abrupt rally and rapid reallocation.Historically, under a “moderately accommodative” policy stance, A-shares have shown a strong beta effect, and this time is expected to be no exception.

In the short term, the Central Economic Work Conference scheduled for 12 11–12 will be an important point for gauging intentions going forward. Although the conference may not provide specific figures, its directional guidance on key support areas will be crucial.

Clear signals of a policy shift have arrived, and markets need to prepare for larger interest-rate adjustments and asset-price revaluations. These changes will emerge gradually over the coming months. Ultimately, this round of “moderately accommodative” policy is not a return to the experience of 2008, but more likely a new test of policymakers’ ability to manage market expectations.

2024.12.11

China’s unusual debt accumulation

Using a narrow definition of debt—that is, adding bank credit to the private sector to government debt—over the past 150 years, the only country with a pace of debt accumulation similar to China’s, apart from European countries during the First World War, was Japan. Yet when Japan’s debt was growing rapidly, its income level was three times China’s.

 Chart: China’s debt accumulation is unusual among middle- and low-income countries in peacetime

After removing financial deepening

In fast-growing economies, debt growth and even a modest rise in the debt-to-GDP ratio are not unusual; they are a natural result of financial deepening.

To account for the effect of this “financial deepening” on debt growth, one can calculate the change in the debt-to-GDP ratio over a 7-year period, then estimate the expected increase in the debt-to-GDP ratio based on the change in per capita income over the same 7-year period.

Short-term data may be affected by temporary fluctuations, while an overly long time span may obscure dynamics within the cycle.This 7-year timeframe provides a medium-term perspective that can reflect the trend relationship between debt growth and economic growth.

The key to this step is removing the natural component of debt growth caused by “rising income levels”.First, calculate an economy’s actual change in its debt-to-GDP ratio over 7 years (actual debt growth), then estimate the economy’s “expected” debt growth based on the change in per capita income over the same period (that is, the reasonable debt expansion attributable to income growth).

However, even after accounting for financial deepening, specifically, as of 2015, China’s adjusted percentile for 7-year debt/GDP growth reached 96%—surpassing almost all comparable cases。Among the 1960-2023 sample, only three countries met the criteria of a “global GDP share above 10%” and adjusted 7-year debt/GDP growth exceeding 25 percentage points:2007-2013 in the United States, 1986-2000 in Japan, and 2012-2020 in China.

2024.12.12

Rising Debt: Vulnerability Mechanisms

From Japan’s debt bubble in the 1980s to the credit boom in the United States in the 2000s, the outcomes of both explain why rapid debt growth is concerning. High debt levels make the financial system and macroeconomy more sensitive to external shocks, while rapid debt accumulation makes demand-side (spending/demand) adjustments more likely when growth slows.

The core issue is that debt-driven economic activity has significant path dependence.

A new debt issuance can directly support an equal amount of spending. For example, if debt increases by 100 dollars, it may generate an additional 100 dollars in consumption or investment spending.But to maintain this level of spending, the debt stock must continue to grow at the same pace in the future (increasing by 100 dollars each period). Once debt growth slows, the additional spending previously driven by debt cannot be sustained, and economic activity may quickly fall back to its baseline level without debt support.

Furthermore, from a dynamic perspective, The growth rate of spending is related not only to the level of debt, but even more closely to the acceleration of debt growth (the second derivative of credit).When credit growth begins to slow from a high level, that deceleration is transmitted directly to spending growth, negatively affecting aggregate demand. Credit cannot grow exponentially forever; once it reaches a turning point, economic adjustment is inevitable.

2024.12.12

II. Insights 

Our Viewpoints and ideas on market.

Trading Expectations: Fast Announcement, Slow Implementation

Tariffs, taxes, immigration, and regulation are the four core variables in market pricing. The new government’s post-election policy cadence is clear: announce quickly, implement slowly. This combination is market-friendly in the short term, with clear risks in the medium term.

At present, the broad backdrop for U.S. equities is an expectation that policy will follow the path of Fast Announcement, Slow Implementation. “Slow Implementation” supports risk assets, The negative effects of tariffs and immigration policies will take time to materialize, while positive expectations for taxes and regulation are driving valuation expansion.

Actual implementation inevitably lags behind psychological expectations.

The biggest risk right now is the asymmetric distribution of risks from rapid implementation. If tariffs become comprehensive or immigration policies are accelerated, stagflation risks will intensify and market logic will quickly shift from momentum trading to defensive pricing. So when rebalancing, either use a more balanced mix or keep a close watch, If this paradigm shift comes, it will happen quickly; don’t hesitate then.

The main strategy is to take advantage of the time lag between policy announcements and implementation, focusing on sectors with stronger fundamentals that benefit from lower rates and deregulation, while adopting some defensive strategies for highly valued, policy-sensitive sectors. The bullish case for the dollar remains intact. Rotation between cyclical and growth stocks needs to adjust dynamically to the policy timeline. Keep positioning flexible in the near term to capture structural opportunities amid volatility.

Key context for several core variables

1) High tariffs on Chinese goods are the most readily implementable policy. Existing executive authority is sufficient to support them, and implementation does not require congressional approval.But expanding their scope is constrained by the budget reconciliation process, and they also lack broad support within Congress. For markets, thisThe “limited coverage, phased implementation” approach will mitigate the impact on supply chains in the short term, but the risk of gradual escalation in the medium term cannot be ignored.

If policy shifts to “comprehensive coverage, rapid implementation,” stagflation risks will emerge. Once tariffs are fully implemented, they will certainly weigh on GDP growth and push up imported inflation, strengthening the dollar through safe-haven liquidity dynamics, while consumer and retail sectors will face systemic pressure, Market logic will shift from trading expectations to pricing actual impacts.

2) Taxes: the continuation of tax policies may be completed before the final deadline in 2025, while political wrangling over extending, raising, or cutting taxes will slow the process, The marginal improvement in corporate earnings will lag policy implementation, limiting its short-term alpha contribution to the market.

3) Immigration: adjustments to immigration policy may be announced quickly, but their actual impact in reducing labor supply will take time. Structural changes in the labor market will affect wage growth and consumer purchasing power over the medium term, The market is currently underpricing this variable.

4) Deregulation is expected to be announced quickly, but the implementation cycle is long; historical experience shows that rewriting rules takes a great deal of time. This variable provides substantial valuation support to highly leveraged industries such as energy and finance, but does little to boost short-term earnings, The risk to watch is the mismatch caused by expectations of policy implementation being brought forward.

2024.12.09

Short Dollar: The Pain Trade

Over the past few days, I’ve seen some investors who are skilled at Pain Trades contemplating a short-dollar position. The risk is very, very high. I’ll explain the rationale for this trade here; the risk really is very high, so this is just for everyone’s information.

For some investors who like to go against the trend, the risk/reward profile of shorting the dollar now is attractive. On the one hand, the dollar’s good news is already heavily priced in, including strong U.S. data, optimistic expectations for fiscal and trade policy, and the market’s pricing of the Federal Reserve’s rate-cut path.

Positioning data show that dollar longs are significantly overweight. Technical indicators such as RSI point to market sentiment being overly one-sided, and the current economic surprise index (ESI) is close to a historical high. If data start to diverge from expectations, sentiment could reverse quickly and sharply.The current consensus long positioning in the dollar is not only a concentration of risk, but also the perfect setup for a pain trade in the eyes of some.

The three pillars of the bullish dollar case have begun to wobble:First, the advantage in U.S. data remains, but the market has overvalued it; extremes in ESI often come with expectation adjustments, and the “surprise window” for economic growth may have closed. Second, the market is too optimistic about the impact of trade policy changes, especially significantly overestimating the potential expansion of tariffs to regions outside China. Third, the mismatch in the Federal Reserve’s rate-cut path offers clear downside potential for the dollar, The market currently prices in rate cuts at only the next four meetings 50bp; this pricing gap will become explosive when the Federal Reserve cuts rates further.

12 is a key window for short-dollar positions:Upcoming CPI data (12/11) may come in below market expectations, reinforcing expectations of continued Federal Reserve rate cuts; the FOMC meeting (12/18) is currently expected to deliver a 25bp rate cut while also signaling the future path of cuts. Any subsequent deviation from current pricing would greatly weaken the support that front-end rates provide to the dollar; the ECB meeting (12/12) could dampen bullish sentiment toward the dollar with a mildly dovish stance. Meanwhile, if the CN Central Economic Work Conference delivers more easing than expected, it would drive the renminbi higher and curb the dollar’s relative strength.

From a trading perspective, AUD/USD and GBP/USD are actually the best expressions, as both have lower exposure to trade tensions and offer higher carry, while their technicals are near the lows of their historical ranges, giving these long trades a clear risk/reward advantage.

EUR/USD face yield and fundamental headwinds over the long term, but short-term risks have tilted to the upside. Extremely pessimistic market pricing of the euro offers the possibility of a technical rebound, with short covering as a key driver. Trade risks are already largely priced in, leaving limited room for further downside; an upside surprise could instead prompt the market to reassess the euro’s potential.

2024.12.09

Politburo meeting: the most pro-stimulus tone in a decade?

The meeting clearly set the policy direction, placing consumption-driven demand expansion at the center. This wording is clearly a policy correction in response to weak domestic demand. The dual easing path for fiscal and monetary policy strengthens the credibility of the policy signal, but the key lies in the pace and intensity of actual implementation. Real estate and consumer sectors may benefit from this policy push, while the bond market may rally further on larger liquidity injections and expectations of rate cuts. In addition, expectations of economic recovery and policy support may attract more foreign investment into renminbi assets.

In short, short-term risks are greater than in the previous policy trade, and short-term returns are lower. Rather than an endpoint, this is more likely the true starting point of a long-term trade. Make your own decision.

The Politburo meeting sent a strong signal of support for consumption, which directly drove a reversal in offshore Chinese markets despite their initial weakness at the open. The meeting mentioned greater support for consumption, policy preferences for the real estate sector, and a shift toward moderately accommodative monetary policy, but Clearly, the phrase “boost consumption forcefully” is the central focus of current market trading.

Chart: Offshore Chinese equities rallied sharply after the Politburo meeting, with HSCEI/HSTECH rising 3%/4%, respectively.

Morgan Stanley’s Robin Xing also commented on the meeting, saying“The pre-CEWC Politburo meeting sent most aggressive stimulus tone in a decade.”This Politburo meeting sent the strongest stimulus signal in a decade ahead of the Central Economic Work Conference.

The meeting’s statement exceeded market expectations, especially given that expectations for its outcome had been relatively subdued beforehand.Compared with the 9 meeting, this time the meeting’s wording included many new phrases, indicating that policy thinking is gradually shifting from supply-side adjustments toward demand-side balance.

The key statements concern the following points:

1) The wording on monetary policy has shifted to “moderately accommodative.” This is the first time since 2011. We may see larger rate cuts in the future (an estimated 40-50bp reduction next year), while the People’s Bank of China may use new tools more proactively, such as government bond purchases (CGB) and direct repo operations, to increase liquidity.

2) Fiscal policy emphasized “more proactive” measures and added the phrase “strengthen countercyclical adjustments,” indicating that the policy mix will tilt further toward easing. It explicitly called for “actively promoting consumption, increasing investment returns,” and “comprehensively expanding domestic demand.” Judging by the wording, this is clearly a direct response to the current problem of insufficient demand。

3) Emphasized the leading role of economic reform in driving the economy, while also proposing expanded high-standard opening-up to stabilize trade and foreign investment, reflecting a balance between domestic and external policy considerations.

4) For the first time, “stabilizing the housing and real estate markets” was presented as a combined goal, and “preventing and resolving risks in key areas and external shocks” was added. “External shocks” clearly refers to uncertainties in the international trade environment, such as tariffs. “Stabilizing expectations and reviving the economy” was also added, which reflects policymakers’ concern about subdued market expectations and a lack of “animal spirits”。

The Central Economic Work Conference will also take place this week. With the Politburo meeting having significantly boosted market sentiment, the market will certainly expect more policy details to follow. If policy has indeed shifted, then not only the Chinese market, some lagging sectors in European and U.S. markets outside China, such as luxury goods and mining stocks, and even some commodities, could see further catch-up gains.

It should be noted that this meeting did not provide quantitative figures for specific stimulus measures, and the upcoming Central Economic Work Conference, which is likely to take place on 12/11-12, may also offer no clearer details. This may explain the relatively moderate market reaction.

In fact, the direction of the bond market is more important than the meeting itself.

Chart: Government bond yields hit new lows

It never moves in a one-way direction; it fluctuates both ways. This time, the consensus in its direction may mean something more.

Judging from the Politburo meeting’s strong statements, policy implementation may be forceful.

From a market perspective, given that current offshore positioning is clearly lighter than in 9-10, The tactical rally in the mainland market, driven by policy expectations, may continue. Going forward, attention should focus on the implementation of more proactive policies. With consumption and the property market potentially benefiting further, the A-share market may continue to receive capital inflows and sentiment support in the near term.

Chart: Positioning in the China market

For the medium-term outlook, the consensus among foreign investors is still that the “expansionary fiscal plan” expected to be introduced in 2025 will be investment-led, but the balance between consumption and investment will improve slightly, for example by expanding the trade-in program for consumer goods. On monetary policy, actions from now through the end of 2025 are expected to exceed the market consensus, while the central bank may inject further liquidity by cutting the reserve requirement ratio (RRR) and purchasing government bonds in the secondary market, among other measures.

Meanwhile, the likelihood is rising that the official deficit will reach 4% as a share of GDP, slightly above the previously expected 3.5%-4.0%; the market should interpret this positively.In addition, more quasi-fiscal expansion measures, such as special bonds issued by central state-owned enterprises, may also be adopted, further strengthening policy support.

Chart: Trading flows in the China market

We do not view this as the end of the trade. On the contrary, looking back much later, this may well prove to be the true starting point of a long new trade, which also means there is no need to rush in; there is still a long road ahead.

2024.12.10

III. Market Pulse 

Our latest Comments on the economic and market environment

Note: All content in this text is for reference only, does not constitute investment advice, and does not serve as a basis for any laws, regulations, or regulatory policies. Investors should not use or rely on this information as a basis for their decisions.

A Fed focused on liquidity

The message here is that although QT is continuing and the balance sheet is gradually shrinking, the potential liquidity release from lowering the ON RRP rate could ease funding tightness to some extent, creating a potentially favorable backdrop for risk assets.

The minutes of the latest FOMC meeting indicated The Fed is considering lowering the ON RRP (Overnight Reverse Repo Facility) rate.This development reflects the Fed’s continued focus on liquidity management and could have multiple effects on the market.

ON RRP: Background and current situation

ON RRP was an important tool introduced after the pandemic, primarily intended to to provide money market funds (MMFs) with a safe place to park cash and prevent yields from entering negative territory because of excess liquidity. At the time, large-scale QE and fiscal stimulus prompted MMFs to buy short-term Treasury securities in large quantities, putting yields at risk of falling below zero.

However, the situation today is completely different. The yields on ON RRP are more attractive than those on short-term Treasury securities, such as T-Bills, so large amounts of money remain parked in RRP rather than flowing into the bond market or the broader economy.The Fed plans to lower the ON RRP rate to encourage MMFs to shift funds from RRP into T-Bills.

Potential liquidity injection

If MMFs transfer funds from ON RRP to T-Bills, this process would effectively put cash back into the banking system, increasing reserves and system-wide liquidity.Although the balance of ON RRP has fallen to a cyclical low, there is still around 1500 hundred million dollars of potential liquidity reserves, which is no small amount. This is particularly relevant as the Fed is conducting quantitative tightening (QT); such an operation would offset part of the liquidity drain caused by balance-sheet reduction.

2024.12.11