In the past two months, the rise in the yield of US 10-year Treasury bonds has aroused global financial market attention. What is the future trend of China-US 10-year Treasury bond yields? What impact will it have? The author will analyze this.
In 2021, the U.S. 10-year Treasury bond yield may continue to rise,
But the upside is more limited
Regarding the US 10-year Treasury bond yield in 2021, the current mainstream view is that it may be close to or even exceed 2.0%, but there are also views that it will exceed 2.5%. The author believes that it can be analyzed from the three perspectives of macroeconomics, government debt, and the coordination of fiscal policy and monetary policy.
First of all, from the perspective of the macroeconomic trend, there is no basis for a substantial increase in the yield of the US 10-year Treasury bond. From 2016 to 2019, the annual averages of the quarterly gross domestic product (GDP) growth rates of the United States were 1.7%, 2.3%, 3.0%, and 2.2%, respectively. In 2020, affected by the epidemic, the GDP growth rate of the four quarters of the United States was 0.6%, -9.0%, -2.6%, and -1.9% respectively. Although the recent large-scale vaccination is expected to boost the US economy, a strong rebound in the US economy is more likely to occur in the second half of 2021 or even 2022. According to the forecast of the International Monetary Fund (IMF) in January 2021, the growth rate of the U.S. economy from 2020 to 2022 will be -3.4%, 5.1%, and 2.5%, respectively.
The US seasonally adjusted consumer price index (CPI) year-on-year growth rate dropped from 2.5% in January 2020 to 0.2% in May of the same year, then rebounded to 1.4% in September of the same year, and rose to February 2021. 1.7%. The US seasonally adjusted core CPI year-on-year growth rate was 2.3% in January 2020 and dropped to 1.3% in February 2021. From the perspective of price trends, it is unlikely that the US core CPI will continue to significantly exceed 2% year-on-year growth in the short term.
From January to February 2020, the seasonally adjusted unemployment rate in the United States was 3.5%, the lowest level since World War II. Affected by the epidemic, this indicator soared in April 2020 to a peak of 14.8% after World War II. In February 2021, although this indicator has fallen back to 6.2%, it is still significantly higher than the level before the outbreak. More importantly, the labor participation rate in the United States dropped from 63.3% in February 2020 to 61.0% in January 2021, and in February 2021 it only rebounded to 61.3%. From the perspective of changes in the overall unemployment rate and labor productivity, the new crown pneumonia epidemic will continue to have a negative impact on the US labor market.
Secondly, judging from the changes in the size of the US federal government’s debt, the significant increase in the yield of US 10-year Treasury bonds will increase the fiscal pressure on the US government. In 2020, in order to cope with the impact of the new crown pneumonia epidemic on the US real economy and financial markets, the US government has used huge financial funds to rescue the market. In 2020, the U.S. comprehensive fiscal deficit will account for 14.9% of nominal GDP, which is significantly higher than the 9.8% after the outbreak of the U.S. subprime mortgage crisis in 2009. The increase in fiscal deficit will inevitably lead to an increase in the scale of government debt. From 2019 to 2020, the proportion of US federal government debt to nominal GDP has soared from 108.3% to 132.5%. This means that if the U.S. Treasury bond yield rises by 1 percentage point, the increase in interest payments on federal government debt will increase significantly. In order to avoid excessive short-term fiscal pressure and government debt pressure, the US government has a strong incentive to stabilize the 10-year Treasury bond yield at a low level.
Finally, from the perspective of fiscal policy and monetary policy coordination, in order to cope with the implementation of the Biden administration’s $1.9 trillion fiscal deficit plan, the Fed will still reduce fiscal financing costs through a large-scale quantitative easing policy. In September 2008, before the U.S. subprime mortgage crisis broke out, the total assets of the Federal Reserve were less than US$1 trillion. In the six years since the subprime mortgage crisis broke out, the Fed implemented three rounds of quantitative easing monetary policy. At the end of 2014, the total assets of the Federal Reserve rose to $4.5 trillion. However, after the outbreak of the new crown pneumonia epidemic, the total assets of the Fed have expanded from US$4.16 trillion at the end of February 2020 to US$7.59 trillion at the end of February 2021. Taking into account the US$1.9 trillion fiscal rescue plan of the Biden administration, it is roughly estimated that the total assets of the Fed may reach more than US$8.5 trillion by the end of 2021. This means that instead of reducing the scale of quantitative easing because of the increase in inflation, the Fed will implement a larger-scale quantitative easing policy because of the fiscal stimulus policy, which will help stabilize the level of long-term Treasury bond yields.
In summary, considering that the U.S. economic recovery is not yet stable, the pressure on government debt has soared after the outbreak of the new crown pneumonia epidemic, and the Fed’s financing of the government’s expansionary fiscal policy in the next stage, it is expected that the U.S. 10-year Treasury yield will increase in 2021. The increase will be more limited. In 2021, the U.S. 10-year Treasury bond yield is likely to exceed 2.0%, but from the current point of view, the possibility of exceeding 2.5% is very small. Specifically, the U.S. 10-year Treasury bond yield is close to the top in the short term, and the next one or two quarters may show two-way fluctuations. By the end of 2021, with the implementation of a new round of fiscal easing in the United States, economic growth in the United States may continue to rebound, and inflation expectations will be strengthened accordingly, which may push the yield of the 10-year US Treasury bond to rise again.
China’s 10-year treasury bond yield may fluctuate in both directions around current levels
In 2020, China’s GDP growth rate will reach 2.3%. China’s total GDP exceeds 100 trillion yuan (approximately US$14.7 trillion), accounting for 17% of the world’s total economy. Against the background of the raging global new crown pneumonia epidemic in 2020, China has become the only country in the world’s major economies with a positive GDP growth rate. It is not easy to achieve this result.
From the perspective of the troika, the performance of China’s economic recovery in 2020 is uneven. Exports, real estate investment, and infrastructure investment performed relatively well, while consumption and manufacturing investment performed relatively weakly. In 2021, the growth rate of consumption and manufacturing investment will continue to recover, while the growth rate of exports and real estate investment may not continue to improve, and the growth rate of infrastructure investment will be uncertain. It is expected that the real economic growth rate in 2021 will not be too high.
However, as the year-on-year growth rate of China’s quarterly GDP in 2020 will show a significant low before and high under the impact of the epidemic, the year-on-year growth rate of quarterly GDP in 2021 will be greatly disturbed. In the first quarter of 2021, the year-on-year GDP growth rate may reach or exceed 18%, the second quarter may fall to around 10%, and the third and fourth quarters are expected to further fall to 7% and 5%, respectively.
Judging from the monetary policy in 2020, the monetary policy is generally very loose before May 2020. For example, in the first four months of 2020, the central bank implemented three RRR cuts. After May 2020, there has been a significant marginal tightening of monetary policy. With the economic growth rate still significantly lower than the potential economic growth rate, this move reflects the balance of monetary policy between maintaining growth and preventing risks.
The author believes that China’s monetary policy operations in 2021 should be more discretionary and cautious, and to avoid excessive tightening of the policy resulting in a de facto “swift turn”. The main reasons are as follows:
First, as mentioned earlier, economic growth in 2021 will be restricted by some structural factors. Whether it is consumption growth or manufacturing investment growth, there is a high probability that it will only recover moderately. However, due to the strengthening of regulatory policies and changes in the external environment, the growth rate of real estate investment and export growth may fall. In 2021, China’s economy will still face certain pressure to maintain growth, especially after eliminating the factor of high year-on-year growth caused by the base period effect in the first half of 2021.
Second, although the price trend may rebound in 2021, the rebound may be limited. In the first two months of 2021, the year-on-year growth rates of China’s CPI were -0.3% and -0.2%, and the core CPI excluding food and energy prices were -0.3% and 0, respectively. This means that in the short term, China will even face a certain degree of deflationary pressure. The year-on-year growth rate of China’s factory price index (PPI) of industrial products in the first two months of 2021 is expected to be 0.3% and 1.7% respectively. It is estimated that China’s CPI growth rate will be 1.0% to 1.5% in 2021, and the PPI growth rate will be around 3%. Inflationary pressure will not be the main consideration for monetary policy tightening in 2021.
Third, in the second half of 2020, the reason why China’s monetary policy has the confidence to tighten marginally is due to the very loose fiscal policy in 2020. Compared with 2020, the marginal tightening of China’s fiscal policy in 2021 is mainly based on the following considerations. First, the central fiscal deficit as a percentage of GDP was lowered from 3.6% to 3.2%. Second, the issuance of special treasury bonds to fight the epidemic will not continue in 2021. Third, the quota of newly-added local special bonds in 2021 will be reduced by 100 billion yuan from 2020. Taking into account the decline in land transfer income of local governments and the increase in the difficulty of issuing debt financing, the marginal tightening of the broad fiscal policy will undoubtedly be more significant. On the premise that the fiscal policy has determined the marginal tightening, if the monetary policy is tightened too quickly, the superposition of the two policy tightenings may lead to a “swift turn” of the policy.
Fourth, at the end of 2020, there has been a wave of collective defaults on local state-owned enterprise credit bonds in China’s financial market. Although it came to an end due to the timely intervention of the central government, local governments and state-owned enterprises still face great pressure on debt repayment. Especially considering that the debt stocks of local governments and local enterprises are relatively large, once the financing interest rate rises significantly, the pressure of new debt service will also rise rapidly. In order to prevent and defuse the systemic risks that may arise in the credit bond market, it is also necessary to avoid the long-term risk-free interest rate rising too fast in the process of economic recovery.
Fifth, in the second half of 2020, the RMB exchange rate against the US dollar will rise by 8%. The main reason for this round of RMB exchange rate appreciation is the widening of the Sino-US interest rate gap, which has led to a large amount of short-term capital inflow to arbitrage. If the RMB exchange rate continues to rise rapidly, on the one hand, import and export channels may impact China’s economic growth. On the other hand, it may threaten China’s financial stability due to the inflow of hot money and rising asset prices. Therefore, avoiding excessively widening of the Sino-US interest rate spread and exacerbating the pressure of RMB exchange rate appreciation should also be one of the factors that need to be considered when making monetary policy decisions.
In summary, the author believes that China’s monetary policy operations in 2021 will be more flexible and flexible, and will make decisions based on high-frequency macroeconomic data without unidirectional easing or tightening. This means that whether it is the short-term interest rate of the inter-bank market or the yield of long-term government bonds, it is a high probability event that there will be two-way fluctuations at the current level. For example, the yield of China’s 10-year treasury bond is expected to show two-way fluctuations around the central level of 3.3% in 2021.
The Potential Impact of the Trend of China-US Bond Yield on Domestic and Foreign Asset Prices
First, the rise in the yield of US 10-year Treasury bonds will simultaneously suppress the prices of risky assets and safe-haven assets. In 2021, the price volatility of the US stock market and Bitcoin will remain high. Bond and gold prices will also be suppressed by rising U.S. Treasury yields. The dollar index will benefit from rising US Treasury yields. In the next period of time, the US dollar index will consolidate in both directions at the level of 90-91, and by the end of 2021, the US dollar index may rebound significantly again.
Secondly, the yield of China’s 10-year treasury bond fluctuates in two directions around the current level, and its impact on various assets is relatively limited. After this round of adjustment is over, the stock market may continue its relatively good trend in the second half of 2021. Although the long-term risk-free interest rate will not rise significantly, the phenomenon of large-scale defaults on credit bonds in 2021 may be staged again. The real estate market regulation will continue to maintain current policies, and housing prices in first- and second-tier cities will generally stabilize.
Finally, if the US 10-year Treasury bond yield continues to rise and China’s 10-year Treasury yield fluctuates in both directions, then the long-term interest rate differential between China and the United States will continue to narrow for a period of time. In 2020, the difference in the yield of 10-year Treasury bonds between China and the United States once widened to 250BP, and now it has fallen to about 150BP. It is expected that it may continue to narrow to 100-120BP in 2021. The narrowing of the China-US interest rate spread has at least the following two implications. First, the inflow of securities investment funds in China’s capital account in 2021 may be smaller than in 2020. Second, the rate of increase in the RMB exchange rate against the US dollar in 2021 will be lower than in 2020. The author believes that the exchange rate of RMB against the US dollar in 2021 may fluctuate in both directions around the central level of 6.5 to 6.6. By the end of 2021, as the U.S. dollar index rebounds, the RMB exchange rate against the U.S. dollar may depreciate significantly.