January thirteenth, two thousand twenty-five to January sixteenth, two thousand twenty-five

I. Foundation 

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

II. Insights 

Our Viewpoints and ideas on market.

America First & how people view the news behind data and expectations 

Trump’s America First policy clearly implies less interest in “endless wars,”This is another reason why we say that inflation trades may not be enjoyable.

On Russia and Ukraine, Trump appointed retired U.S. Army General Keith Kellogg as envoy, and engaged with Zelenskyy and Putin. Ukraine is seeking international security guarantees through a ceasefire agreement, while also suggesting that Neutrality could serve as a basis for negotiations, which means it would give up the possibility of joining NATO.

Russia, for its part, stresses that the 2022 Istanbul agreements must serve as the basis for negotiations, including Ukraine’s recognition of Crimea as Russian territory and the independent status of Luhansk and Donetsk. The establishment of humanitarian corridors and a mechanism for monitoring negotiations have also become key points of discussion. Russia’s resilience to sanctions and Europe’s ability to maintain its defense commitments to NATO under current economic pressure will directly affect the course of future negotiations.

Polls show that the U.S. public is optimistic about the economic outlook, but pessimism about foreign affairs continues to rise. The latest Gallup poll finds that more than 2/3 of respondents expect the stock market to rise over the next year, and more than 50% are optimistic about improvements in employment and inflation. However, 66% are pessimistic about whether international disputes can be resolved peacefully.Partisan divisions remain pronounced: 76% of Republican voters believe U.S. global influence will grow, while Democratic voters take a more cautious view.

This partisan divide in views naturally leads to differing views of the market:

Source: University of Michigan's monthly consumer survey

Republicans have no inflation expectations because the person who “can solve every problem” was elected, while Democrats are the opposite, People’s views of the news lie behind the data and expectations.

2025.01.13

A shift in the risk trade-off: what could stop the decline in U.S. Treasury prices?

If the FOMC meeting in 12 marked an important shift in the Federal Reserve’s risk trade-off back toward inflation, then the 12 employment report delivered the crucial next step in that narrative, Moderate average hourly earnings data avoided a more alarming signal of a renewed inflation pickup, but the case for rate cuts to mitigate labor-market risks has now faded from view.

Discussion of what might stop U.S. Treasury prices from falling, External news is a potential catalyst, but the data available so far continue to reinforce the assessment of the U.S. economy’s resilience in a high-interest-rate environment;Another mechanism that could drive a reversal in yields is when the bond selloff itself begins to create enough of a headwind for growth expectations(or more pronounced negative feedback from rising yields on risk assets).

In fact, the sharp widening of front-end spreads early last week stemmed from news that Michael Barr, the Fed's vice chair for supervision, planned to step down from his supervisory role (Michael Barr) planned to step down from his supervisory role.I wonder if you remember us mentioning this name in Notes241112..

This is also the point of reading Notes,“News” in the market is simply an expectable outcome of probabilistic events for us.

As for Michael, the market expects banking regulation to ease, which could ultimately support banks' demand for Treasuries. Yet, broadly speaking, financing conditions across maturities have already eased significantly over the past two weeks.

Although the knee-jerk shift in the inflation curve after the election seems attributable to rising tail risk from higher tariffs, the subsequent steepening of the curve is more consistent with the market assigning greater weight to the prospect that larger fiscal stimulus will drive growth.Current market trading has made inflation pricing somewhat vulnerable to a resurgence of tariff concerns. If growth concerns arising from tariffs come back into focus, the inflation curve could again face flattening pressure.

2025.01.14

The U.S. Treasury market’s game within a game: Nothing to do with inflation or debt

To reiterate, at least for now, The rise in the U.S. ten-year yield has mainly taken the form of higher real yields and a higher term premium, rather than higher inflation expectations.Meanwhile, as yields rise, the dollar is also appreciating sharply, which does not fit the debt-sustainability narrative either, The divergence between the two narratives points to one conclusion：The current Treasury trade really has nothing to do with inflation or debt.

In the Notes250114 article “From Monetarism to Fiscal Dominance,” we said:“Over the past decade and more, the Fed and other major central banks played the role of “the last resort” through large-scale asset purchases, such as quantitative easing, QE, providing sustained demand for the bond market. This demand effectively pushed down long-term bond yields while suppressing the term premium.

As central banks shrink their balance sheets (QT) or stop buying bonds, the market loses this “backstop demand,”The greater supply of bonds has to be absorbed by the market, which in itself raises the required return on long-term bonds. And rising term premiums will offset the positive effect on bonds of the Federal Reserve’s expected rate-cut path.”

In fact, looking further, changes in foreign central banks' official dollar reserves closely align with the reversal in ten-year yields, The rise in the U.S. ten-year real yield plus term premium of over 70 basis points corresponds almost exactly to the decline of more than 1000 hundred million dollars in dollar reserve assets held by foreign central banks:

Chart: U.S. ten-year Treasury real yields and term premium, and foreign official dollar reserves

The right-hand side of the chart above shows foreign official dollar reserves held in custody at the Fed, including U.S. Treasuries held by foreign official institutions and reverse repos through the Foreign Repo Pool, which together make up dollar reserve assets. While this does not fully establish causality, it at least suggests that sales of dollar reserves may be exerting strong upward pressure on long-term interest rates.

Chart: U.S. Treasury holdings by foreign central banks and their reverse repo positions at the New York Fed

Since 9/18, the initial decline in dollar reserves was driven mainly by a reduction in the Foreign Repo Pool (right chart); however, after the presidential election on 11/6, foreign official institutions shifted to accelerating their sales of U.S. Treasuries (left chart).

Since 11/6, foreign official institutions have sold about 780 hundred million dollars in U.S. Treasuries; as of 1/8, their total holdings had fallen below 2.87 trillion dollars, according to New York Fed data, These sales have brought total foreign official holdings of U.S. Treasuries to their lowest level since the U.S. Treasury market froze in 2020/3.

Notably, the proceeds from U.S. Treasury sales do not appear to have been reallocated to the Foreign Repo Pool, or vice versa. This suggests that, Foreign official institutions are concretely reducing the share of dollar-denominated assets in their portfolios.

If foreign official institutions are selling dollar reserves on a large scale, that naturally raises two questions. First, Which counterparties are taking on these dollar assets? Second, foreign official institutions will which assets are they reallocating the funds to？

U.S. domestic dealer banks are the main counterparties to foreign official sales of U.S. Treasuries They took on the additional supply that other investors did not buy. Dealers' net Treasury positions have reached a record high, Their net U.S. Treasury positions have increased by more than 700 hundred million dollars since the election on 11/6, almost matching the 780 hundred million dollars in U.S. Treasuries sold by foreign official institutions over the same period.

Dealers’ overstretched positions indicate that other structural investor groups in U.S. Treasuries—especially domestic and foreign private investors—have not stepped in actively.In addition, the Fed is still reducing its Treasury holdings on its balance sheet. Therefore, foreign official selling, combined with weak demand for Treasuries from other investors and the dealers' limited capacity to absorb supply, helps explain why the real yield and term premium on 10-year Treasuries rose so significantly; at a minimum, this situation substantially amplified market volatility.

Chart: Treasury holdings of the Fed and dealer banks

Finally, if non-U.S. institutions around the world are reducing their dollar reserve holdings, where has this where did the huge sums of money go?

Outside the United States, falling bond prices and weakening currencies in the United Kingdom, Canada, and Japan suggest that these institutions are unlikely to be shifting from dollar assets into other fiat-currency reserve assets. The chart below clearly shows, They may be reallocating funds to gold as a reserve asset.

Chart: Gold’s differing performance during U.S. and non-U.S. trading hours

Interestingly, although Gold appears to be trading in a range based on its overall price action, but when trading hours are separated into non-U.S. and U.S. sessions, some interesting developments in market structure become quite apparent.

2025.01.16

III. Market Pulse 

Our latest Comments on the economic and market environment

From Monetarism to Fiscal Dominance

The real yield on 30-year U.S. Treasuries has risen to its highest level since 2008, The recent rise in benchmark rates is somewhat independent of long-term inflation expectations and reflects more the market's concern about increased debt supply and fiscal deficits.

Debt worth 14.6 trillion dollars will mature over the next two years, while the Fed is still QT. When the biggest market maker in the largest bond market—the Fed—is absent, yields naturally rise. The Fed's balance sheet has shrunk from 9 trillion dollars to 6.85 trillion dollars, Supply and demand curves are rarely as clear as they are now.

In this term premium cycle, Fidelity's Jurrien Timmer is truly formidable:

“With the Fed and other central banks no longer the buyer of first and last resort, it seems plausible that the term premium might rise in the months and years ahead.”

Over the past decade and more, the Fed and other major central banks played the role of “the last resort” through large-scale asset purchases, such as quantitative easing, QE, providing sustained demand for the bond market. This demand effectively pushed down long-term bond yields while suppressing the term premium.

As central banks shrink their balance sheets (QT) or stop buying bonds, the market loses this “backstop demand,”The greater supply of bonds has to be absorbed by the market, which in itself raises the required return on long-term bonds. And rising term premiums will offset the positive effect on bonds of the Federal Reserve’s expected rate-cut path.

A higher term premium means higher real yields; with stocks and bonds positively correlated, rising rates also lead to stock market volatility, An interest rate scare does not necessarily end a bull market in stocks, but it will certainly weaken bullish momentum.Rate cuts dominated the trajectory of bond yields in the previous cycle, but going forward, the term premium may outweigh the Fed's rate-hiking and rate-cutting cycle.

So, how far can the trade go?

In 24 12, Yellen wrote in a letter to congressional leaders: "Treasury currently expects to reach the new limit between January 14 and January 23, at which time it will be necessary for Treasury to start taking extraordinary measures,” Treasury currently expects between 25 1 14 and 1 23 reach the new debt limit, at which point the Treasury will will need to begin taking extraordinary measures.

These “extraordinary measures” will directly affect subsequent market trends and are the key development we are watching now.

2025.01.14

Extreme market pricing and Inauguration Day actions

Bond market pricing currently implies that the Fed will cut rates only once in 2025, by about 28 basis points, while some participants in the U.S. equity market are currently pricing in 0 cuts, or no rate cuts at all, and the market also expects rates to rise gradually in 2026, until 2026 12.

Chart: Market consensus pricing

Chart: Market-implied probability of a rate hike (next 12 months)

Trump has previously stated emphatically that he prefers a weaker dollar, It is reasonable to expect that the recent “front-running” in the dollar and Treasury yields ahead of Inauguration Day will certainly reduce the likelihood that he immediately takes drastic inflationary actions, such as across-the-board 10% tariffs.

In fact, the extent to which tariffs on China are priced in is now open to question, because China has generally shown a high willingness to cooperate, and relations between China and the U.S. are currently delicate. Given current pricing, Even if tariffs on China, Mexico, and Canada are introduced as expected, they will most likely become a “sell the news” event.

If there is no blanket 10% tariff imposed all at once, the inflation outlook is quite acceptable—or, one could say, it has been fully absorbed and priced in by the market as of now:

If, within 2-3 weeks after Trump takes office, he does not mention higher-than-expected tariffs, war, or territorial annexation, Treasury yields and the dollar will most likely lose momentum, which would benefit emerging-market equities that have been under sustained pressure.

2025.01.15

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