US Treasury Yields Fluctuating Downwards: How Should We Invest?

The recent volatility in the U.S. 10-year Treasury yield has been significant, but the overall trend is expected to be a volatile downward trend. It is almost certain that this round of interest rate hikes is coming to an end, so preparing ahead and reviewing historical experience can help to be prepared for any situation.

（1）Long-term U.S. bond yields peak. Regardless of whether it is due to the end of interest rate hikes, or the macroeconomic background where the economy and markets tend to weaken, the high point for long-term U.S. bond yields generally occurs before the end of interest rate hikes. Historical experience since the 1990s shows that the high point for 10-year Treasury bonds usually leads the end of interest rate hikes by 1-3 months. However, the subsequent trends vary greatly, with most of them being a rapid decline, but there are also exceptions. For example, after the end of interest rate hikes in 2006, the 10-year Treasury bond dropped from 5.2% at the end of June to 4.4% in early December. However, it rebounded again in 2007 and hit a new high of 5.3% mid-year, until the start of interest rate cuts in 2007 caused a significant drop.

（2）The market usually rebounds, with emerging markets leading the way. There is often a small market correction just before the end of interest rate hikes (in some cases, market corrections are also the reason for the end of interest rate hikes, such as at the end of 2018). Once interest rate hikes stop, the market usually rebounds and emerging markets tend to outperform. However, the rebound cannot be simply viewed as the beginning of a reversal and must be combined with specific fundamental conditions. The end of interest rate hikes may also indicate economic or market problems. If these problems cannot be solved solely by stopping interest rate hikes, the market will face even greater pressure afterward, forcing the Federal Reserve to turn to interest rate cuts. This is also why the market often experiences a big drop at the beginning of an interest rate cut cycle. For markets outside of U.S. stocks. The Federal Reserve's monetary policy is an exogenous variable. Therefore, whether the market rebound can continue depends on the subsequent degree of recovery in endogenous fundamentals.

（3）Growth and interest rate sensitivity lead the way. After the end of interest rate hikes, assets that are more sensitive to interest rates, such as growth stocks, tend to perform better. Since the 1990s, one month after the end of interest rate hikes, the Nasdaq has generally outperformed the S&P 500, and the S&P growth style has typically outperformed value.

（4）The U.S. dollar index weakens slightly in the short term, but not necessarily in the medium term. Usually, one to three months after the end of interest rate hikes, the U.S. dollar index fluctuates and weakens slightly in the short term, but the medium-term trend is not necessarily so. In 2019, the U.S. dollar weakened slightly in the short term after the Federal Reserve stopped raising interest rates, but it remained strong for most of the year, even during the interest rate cut cycle between July and September, fully demonstrating that monetary policy is not the dominant factor in exchange rates.

Considering the direction of the macroeconomic cycle, the general trend for U.S. bond rates is downward, but the current position may be overbought; the short-term outlook for U.S. stocks is boosted by the easing of interest rate trends, and the overall market may remain volatile until the downward trend in U.S. bond rates begins; lower real interest rates also boost gold prices, but significant gains may need to "wait a while"; and the U.S. dollar is expected to remain volatile. Specifically,

U.S. bonds: The general trend for U.S. bond rates is downward. Market expectations that the Federal Reserve has stopped raising interest rates have increased since the November FOMC meeting. Coupled with some economic data falling short of expectations, U.S. bond rates fell by about 36bp below 4.6% due to the contribution of real interest rates. Although the central tendency of interest rates is downward, we believe that there is an overbought risk at the current position because logically speaking, the market's spontaneous trading of loose financial conditions will also strengthen the Federal Reserve's expectation of further interest rate hikes or stimulate growth again. On the other hand, the main uncertainty about whether it will hit new highs comes from the subsequent actual issuance of bonds by the Treasury Department (the Treasury Department plans to issue a net $605 billion in bonds in the fourth quarter and $644 billion in the first quarter of next year, compared to $852 billion in the third quarter of this year). In the short term, it is recommended to be patient. If it rises again, you can consider entering the market, and if it drops sharply, you can temporarily make profits.

U.S. stocks: Short-term boosted by the easing of interest rate trends, the overall market may remain volatile. The short-term easing of interest rate trends has boosted the market's recovery, but the overall market may remain volatile due to tightening liquidity until the downward trend in interest rates begins. It is currently expected that the market consensus predicts that S&P 500 earnings growth in the third quarter will rise from -4% in the second quarter to 3.6%, while the Nasdaq remains basically unchanged at 15% compared to the second quarter. From the perspective of earnings adjustment sentiment, the momentum of upward earnings adjustments has slowed recently. Therefore, we do not recommend chasing high stock prices.