·Summary·
Since July of this year, the interest rate of US Treasuries has risen sharply again. The interest rate of US 10-year treasury bond bonds has climbed to more than 5% at the highest, reaching 4.93% on October 20, and the interest rate of 30-year treasury bond has reached 5.09%. What are the driving factors behind the significant increase in US bond interest rates? Is the nominal interest rate of US bonds around 5% too high? Will US Treasury bonds maintain high interest rates for the long term? Looking ahead, what is the trend of US bond interest rates? This article explores these issues.
Risk reminder: The tightening of US monetary policy exceeded expectations, and the US economy exceeded expectations.
Since July of this year, the interest rate of US Treasuries has risen sharply again. The interest rate of US 10-year treasury bond bonds has climbed to more than 5% at the highest, and finally (October 20) it was 4.93%, and the interest rate of 30-year treasury bond reached 5.09%. What are the driving factors behind the significant increase in US bond interest rates? Is the nominal interest rate of US bonds around 5% too high? Will US Treasury bonds maintain high interest rates for the long term? Looking ahead, what is the trend of US bond interest rates? This article explores these issues.
1
Direct cause: increase in actual interest rates
If the nominal interest rate of US Treasury bonds is divided into real interest rate and inflation expectation, in fact, there has not been much change in US inflation expectation since the beginning of this year, that is, the impact of inflation on US Treasury interest rates has been weakened. Since the beginning of this year (as of October 20, the same below), the interest rate of the US 10 issue treasury bond has risen by 105 BP, of which the inflation expectation has only risen by 17 BP, and 16 BP have risen since the emergence of the Palestinian Israeli problem. Before October, the US 10 year inflation expectation was stable at around 2.3%. Although this level is slightly higher than before the pandemic (with an average of 1.7% in December 2019), at least it indicates that the market expects the Federal Reserve to be able to stabilize inflation in the long term.
From the perspective of actual inflation, as of September, the core CPI in the United States was 4.1% year-on-year, with a consecutive three month month on month growth rate of 3.1% year-on-year. The core CPI is still in the downward channel. Although short-term oil prices face certain uncertainties, their impact on inflation expectations is relatively limited.
In fact, the most important variable driving the upward trend of US Treasury nominal interest rates since the beginning of this year is the significant increase in US real interest rates (nominal interest rates minus inflation expectations). The current 10-year US Treasury bond real interest rate has rebounded to around 2.5%, while before the outbreak of the epidemic, it was even less than 0.2% (December 31, 2019: 0.15%), and the average level between 2013 and 2018 was only 0.42%. If we do not consider the extreme situation of the US dollar liquidity crisis during 2008, the current real interest rate on US bonds has returned to the level before the 2008 financial crisis.
2
The actual interest rate of US bonds: Is it too high?
So is the current real interest rate on US bonds around 2.5% too high? Whether the financing cost is high or low can be compared with natural interest rates, which can be understood as the level of interest rates at which the economy and inflation reach a stable state. Regarding natural interest rates, different calculation models estimate different results. The current natural interest rate level measured by the LW model of the New York Federal Reserve in the United States is around 1.14%, while the HLW model measures the natural interest rate level around 0.57%, both of which are lower than the levels before the pandemic. Of course, their model calculates that the potential growth rate in the United States is also lower than before the pandemic, which means that after the pandemic, the economic growth trend in the United States has slowed down, and the level of interest rates that can be borne has also decreased. If calculated by the New York Fed, the current real interest rate level around 2.5% is significantly higher than the natural interest rate level, and it is already exerting a significant tightening effect on the economy. From this perspective, the necessity for the Federal Reserve to raise interest rates again is not significant. However, the Richmond Fed's model calculates a much higher level of natural interest rates in the United States, currently around 2.28%. In the two years before the epidemic, their calculated natural interest rate level in the United States was only around 1.5%, which means that after the epidemic, the natural interest rate level that the US economy can withstand has significantly increased. Although the economic growth rate of the United States has not been higher than before the pandemic, there are many factors that affect the level of natural interest rates, not only economic growth, but also population structure, fiscal deficit, trade deficit, and so on. Therefore, the natural interest rate of the United States may indeed increase. However, even compared to the natural interest rate of over 2% calculated by the Richmond Fed, the current level of real interest rates on US bonds around 2.5% is still too high, achieving the goal of tightening.
Of course, the concepts of natural interest rates and potential growth rates are similar, both calculated through models, and the calculation results largely depend on the setting of model parameters. If the parameters are slightly adjusted, the calculation results may also be significantly different. So using natural interest rates to measure the level of US bond interest rates can only serve as a reference.
We can also compare the actual interest rate of US bonds with the actual economic growth rate of the United States. As of the second quarter of this year, the real GDP growth rate in the United States was 2.38% year-on-year, and the quarter on quarter growth rate was 2.1% year-on-year; However, the GDP growth rate in the third quarter of the United States may have significantly increased. According to a Bloomberg survey cited by Huitong Finance, it is expected that the year-on-year growth rate will be 4.3%, and the Atlanta Fed's GDPNow model even predicts a 5.4% growth rate. However, this is after all a single quarter's year-on-year growth rate, and we believe that the probability is difficult to sustain. Between 2013 and 2018, the actual economic growth rate in the United States was approximately 2 percentage points higher than the average 10-year real interest rate. If estimated based on the average 2.4% year-on-year growth rate of US GDP in the past four quarters, the current real interest rate around 2.5% may also reach a restrictive level.
Overall, from the perspective of natural interest rates and US economic growth, the current interest rate level of US bonds may be slightly higher.
3
Broad fiscal policy and tight monetary policy: constituting short-term shocks
Both the nominal and actual interest rates of US Treasuries are actually the result of market transactions, so they are also influenced by short-term trading factors, especially the short-term supply and demand relationship of US Treasuries. This year's macro environment in the United States can be summarized as a broad fiscal and tight monetary policy. In the first quarter of last year, the US fiscal deficit rate dropped as low as 2.5%, while it has rebounded to 7.2% in Q1 and 7.7% in Q2 this year, reflecting the active support of the government for the economy.
In the context of stable economic recovery, the US deficit rate is still expanding, which is relatively rare in history. In the past, US fiscal policy had a typical "countercyclical" regulatory effect, while in this round of US unemployment rate being low and economy and inflation being high, US fiscal policy is still expanding significantly, even demonstrating a "pro cyclical" regulatory effect.
In a better economy, the significant widening of the US fiscal deficit is related to the disturbance of some short-term factors. From the perspective of income, the most obvious one is to provide residents with "disguised" tax reductions. Since the beginning of this year, the income and economy of American residents have continued to grow steadily, but the personal income tax revenue of the US government has significantly declined. The last time such a significant decline occurred was after the 2008 financial crisis, but it was in an economic downturn environment at that time. The decline in personal income tax for residents in this round is mainly related to the tax collection mechanism in the United States, which adjusts personal income tax collection based on inflation levels. Last year, the inflation level in the United States was relatively high, so the threshold for personal income tax collection has been significantly raised this year, which is equivalent to a significant tax reduction for the residential sector. In addition, due to the rapid and significant upward trend of US interest rates in this round, the dividend income provided by the Federal Reserve to the US Treasury has also significantly decreased, which has also affected fiscal revenue.
From the perspective of expenditure, in addition to the significant increase in fiscal interest payment pressure, the US government's power in the economy and industry is increasing. In November 2021, the United States passed the "Infrastructure Act", and in 2022, it passed the "Chip Act" and "Inflation Reduction Act". The government's role in the economy has significantly increased, and since the second quarter of 2022, the US government's investment spending has started to significantly increase.
While the deficit is rising and the supply of US Treasury bonds is increasing, the Federal Reserve's monetary policy is tightening under inflationary pressure, with interest rate hikes and balance sheet contractions advancing simultaneously, reducing demand for US Treasury bonds. Since June, the amount of US bond issuance that the market needs to digest has significantly increased, especially in the third quarter. The average monthly net increase in US bond issuance that the market needs to digest over the past three months has been over $300 billion, which may have an impact on both the nominal and actual interest rates of US bonds.
4
How do you look forward? Configuration value or already evident
In terms of monetary policy, there is a high probability that the Federal Reserve will maintain the status quo for a period of time. Because the inflation level in the United States is still above the target value, the possibility of the Federal Reserve reducing interest rates in the short term is very low, and it will continue to shrink its balance sheet and maintain a tight monetary policy. At the same time, the long-term real interest rate in the United States has risen to around 2.5%, and the short-term real interest rate measured by subtracting core inflation from the 2-year nominal interest rate is also close to the 2007 level. If the neutral interest rate in the United States had not significantly increased, the current interest rate level may have reached a "restrictive" level, and the need for the Federal Reserve to further tighten monetary policy is not significant.
So the key factor that will affect the short-term trend of US bonds next is US fiscal policy. From the perspective of expenditure, with the advancement of refinancing, the pressure on US fiscal interest payments will continue to increase, and the intensity of US infrastructure, semiconductor and other fiscal expenditures is expected to continue to maintain. However, considering the recent personnel changes in the US Congress, the probability of further significant new fiscal expenditures in the short term is relatively small. From the perspective of income, the inflation level this year has decreased compared to last year, so the increase in the threshold for personal tax collection may be smaller than last year, so the decrease in personal tax fiscal revenue is expected to narrow. According to the outlook of the Congressional Budget Office, it is expected that there may be a slight decrease in the increase in US federal debt in the next fiscal year. So overall, the 10-year US Treasury interest rate around 5% may already reflect the allocation value. In the short term, we can continue to pay attention to the continuity of the US fiscal policy, as US bonds may still be impacted by fiscal policy. But from a long-term allocation perspective, current interest rates may already be in the high range. After all, in the long run, the potential GDP growth rate and natural interest rates in the United States may not have increased that much. The debt problem of the US government can be maintained in the short term, but it is still a relatively large problem in the long run.
(Liang Zhonghua is the Chief Macro Analyst of Haitong Securities Research Institute)
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