Has the "premature" interest rate cut expectation been repaired?

Summary

The Two Sessions have convened, and the central bank leadership has set the tone for the annual monetary policy, while the bond market has undergone significant adjustments. How should we view the current allocation value?

At the economic-themed press conference held on March 6, Central Bank Governor Pan Gongsheng provided an outlook on the monetary policy for 2025. In summary, there are two main points of interest: first, a comparison of the monetary policy orientations of China and the United States. Although the Federal Reserve has cut interest rates, the policy rate remains high, indicating a restrictive monetary policy, while the financing costs in our country are at historical lows, reflecting a supportive monetary policy stance. Looking back, the central bank has introduced several new monetary policy tools in 2024, including reverse repos and government bond transactions. Currently, these tools are primarily used for liquidity injection, aligning with the supportive monetary policy stance. As of March 7, the difference between DR007 and the 7-day reverse repo rate is 30.66bp, with the central tendency of this difference from January 1, 2023, to March 7, 2025, being 15.49bp. The current level is at the 87th percentile, clearly deviating from the principle of funding rates fluctuating around the policy rate. Based on this, we believe that the "tight monetary" feeling in the funding market from January to February will ease.

Second, regarding policy transmission, there is a proposal to strengthen regulations on certain unreasonable market behaviors that easily undermine the transmission of monetary policy. Bond investors began to anticipate interest rate cuts in December 2024, leading to a significant reaction to this statement, with the 10-year government bond yield rising by 3.7bp and 5.5bp on March 6 and 7, respectively. Here, we selected two time points: the first being July 19, 2024, when the TS price was roughly the same as on March 7, and the second being December 9, 2024, when the "moderately loose" monetary policy tone was proposed. By comparing the current yields of government bonds across various maturities with those at these two time points, we can observe whether the bond market has corrected after the anticipation of interest rate cuts.

From Table 1, it can be seen that the yields on government bonds with maturities of 7 years and below have risen to levels prior to the anticipation of interest rate cuts. Coupled with the earlier mentioned judgment that the "tight monetary" feeling will ease, the allocation value of short-term bonds has become prominent, and we expect the yield curve to steepen.

The U.S. manufacturing PMI index, non-manufacturing PMI index, and February unemployment rate data were released. How will U.S. Treasury yields change in the future?

Last week (March 3 - March 7), the long-end U.S. Treasury yields saw a slowdown in their decline, reaching a low of 4.1%. The yield spread between the long and short ends (10y - 2y) is about 35bp, showing some recovery compared to earlier periods. We believe the Federal Reserve will maintain this indicator in the 20-40bp range. Historically, when there is a risk of inversion, the Federal Reserve has acted promptly to lower short-end yields through rate cuts. During the same period, the U.S. dollar continued to depreciate, and the German government's announcement to increase military spending stimulated capital outflows to Europe, boosting the euro, while the yen followed the euro and further oscillated upward The left-side opportunities for U.S. Treasuries and the U.S. dollar have been our consistent view in the overseas context. This is due to our observation of the unsustainability of the U.S. economy's exceptional performance, as well as the weakening rather than improving competitiveness of U.S. enterprises due to the tariffs and geopolitical policies of the Trump administration. Additionally, we are currently observing some marginal signs that non-cyclical factors are hindering the smooth global repatriation of the dollar, which may structurally support the euro and yen. Therefore, we consider the following based on incremental data:

(1) The U.S. manufacturing PMI index fell in February; the non-manufacturing PMI index rebounded in February, exceeding previous values and expectations. The U.S. ISM manufacturing index for February is 50.3, lower than the previous value of 50.9 and the expected 50.8. In terms of important sub-indices: the new orders index is 48.6, down 6.5 points from January's 55.1. Combined with the inventory index rising from January's 45.9 to 49.9, this indicates that the inventory cycle has not yet shown a trend of recovery; the employment index contracted, falling from 50.3 in January to 47.6 in February, with a slowdown in hiring potentially hindering GDP growth. The U.S. non-manufacturing PMI strengthened, with the February non-manufacturing PMI index at 53.5, exceeding the previous value of 52.8 and the expected 52.5. In terms of important sub-indices, the new orders index rose by 0.9 points to 52.2 in February, the business activity index slightly decreased by 0.1 points to 54.4 in February, and the price index rose by 2.2 points to 62.6 in February, indicating a significant rise in prices.

(2) The U.S. unemployment rate rose in February 2025, and non-farm payroll growth fell short of expectations. The official unemployment rate for February, which measures the number of actively seeking unemployed individuals (U3 unemployment rate), is 4.1, higher than the previous value of 4.0 and the expected 4.0. The U6 unemployment rate, which includes temporary workers, is higher than in January, indicating a softening job market in the U.S. to some extent corroborating the decline in the manufacturing PMI index in February. The U.S. non-farm payrolls added 151,000 jobs in February, below the market expectation of 160,000, but higher than the previous value of 125,000, with the largest contributions still coming from the service sector, particularly education and healthcare services (+73,000), contributing nearly 50% of the new jobs.

(3) The Federal Reserve maintains a wait-and-see approach, awaiting clearer economic prospects. On March 7, Federal Reserve Chairman Jerome Powell stated that there is no need to rush to adjust policy rates at this stage, and the Fed can patiently wait for the situation to become clearer, emphasizing that the cost of maintaining caution is very, very low. He highlighted that the uncertainty brought about by changes in Trump’s policies remains relatively high. The Fed is assessing the impact of changes in trade policy, which have exacerbated economic uncertainty. The current focus of the Fed is to distinguish between real signals and market noise during the process of changes in economic prospects. As of March 9, Fedwatch predicts a 12.0% probability of a 25bp rate cut in March 2025, up from 7.0% last week; the likelihood of a rate cut in May is 52.1%, up from 32.0% last week The probability of another interest rate cut in June, following the cut in May, is 38.6%, up from 23.8% last week.

Main Text

1. Weekly Viewpoint

Q1: With the Two Sessions convening, the central bank leadership's statements set the tone for the annual monetary policy, while the bond market has undergone significant adjustments. How do you view the current allocation value at this level?

At the economic-themed press conference held on March 6, Central Bank Governor Pan Gongsheng provided an outlook on monetary policy for 2025. In summary, there are two main points of interest for the market: first, a comparison of the monetary policy orientations of China and the United States. Although the Federal Reserve has cut interest rates, the policy rate remains high, indicating a restrictive monetary policy. In contrast, China's financing costs are at historically low levels, and the monetary policy stance is supportive. Looking back, the central bank has introduced several new monetary policy tools in 2024, including reverse repos and government bond transactions. Currently, these tools are primarily used for liquidity injection, aligning with a supportive monetary policy stance. As of March 7, the difference between DR007 and the 7-day reverse repo rate is 30.66 basis points, while the central tendency of this difference from January 1, 2023, to March 7, 2025, is 15.49 basis points. The current level is at the 87th percentile, clearly deviating from the principle of funding rates fluctuating around the policy rate. Based on this, we believe that the "tight monetary" feeling in the funding market during January and February will ease.

Second, regarding policy transmission, there is a proposal to strengthen regulations on certain unreasonable market behaviors that easily undermine the transmission of monetary policy. Bond investors began to anticipate interest rate cuts in December 2024, leading to a significant reaction to this statement, with the 10-year government bond yield rising by 3.7 basis points and 5.5 basis points on March 6 and 7, respectively. Here, we selected two time points: the first time point is July 19, 2024, when the TS price is roughly the same as on March 7, and the second time point is December 9, 2024, when the "moderately loose" monetary policy tone was proposed. By comparing the current yields of government bonds of various maturities with those at these two time points, we can observe whether the bond market has corrected itself after the anticipation of interest rate cuts.

![](https://mmbiz-qpic.wscn.net/mmbiz_png/ooHwPCC4J5ArNso1zEOhgZN4NFOse23Z4Cib4mVUaa1WLnjkZ5vk4mZJgxT3diaeWOgdcUBDIicbklUPj7Jia47zwQ/640? Through Table 1, it can be seen that the yields on government bonds with a maturity of 7 years and below have risen to levels before the interest rate cut expectations began to take shape. Coupled with the earlier mentioned judgment that the "tight monetary" feeling will ease, the allocation value of short-term bonds has become prominent, and it is expected that the yield curve will steepen.

Q2: The U.S. manufacturing PMI index, non-manufacturing PMI index, and unemployment rate data for February 2025 were released. How will U.S. Treasury yields change in the future?

Last week (March 3 - March 7), the long-end U.S. Treasury yields saw a slowdown in their decline, reaching a low of 4.1%. The yield spread between the long and short ends (10y - 2y) is about 35 basis points, which has improved compared to earlier periods. We believe the Federal Reserve will maintain this indicator in the 20-40 basis points range. Historically, when there is a risk of inversion, the Federal Reserve will act promptly to lower short-term yields through interest rate cuts. During the same period, the U.S. dollar continued to depreciate, and Germany's announcement to increase military spending stimulated capital outflows to Europe, boosting the euro's reversal and further strengthening the yen alongside the euro.

The left-side opportunities in U.S. Treasuries and the dollar have been our consistent view in overseas markets, driven by our observation of the unsustainability of the U.S. economy's exceptional performance. Additionally, the tariffs and geopolitical policies of the Trump administration are weakening rather than improving the competitiveness of U.S. companies. Currently, we are also observing some marginal signs that non-cyclical factors are hindering the smooth global return of the dollar, which may structurally support the euro and yen. Therefore, we consider the following based on incremental data:

(1) The U.S. manufacturing PMI index decreased in February; the non-manufacturing PMI index rebounded, exceeding previous values and expectations. The U.S. ISM manufacturing index for February is 50.3, lower than the previous value of 50.9 and the expected 50.8. In terms of important sub-indices: the new orders index is 48.6, down 6.5 points from January's 55.1. Combined with the inventory index rising from January's 45.9 to 49.9, it indicates that the inventory cycle has not yet shown a trend of recovery. The employment index contracted, falling from 50.3 in January to 47.6 in February, indicating a slowdown in hiring, which may hinder GDP growth. The U.S. non-manufacturing PMI strengthened, with the February non-manufacturing PMI index at 53.5, exceeding the previous value of 52.8 and the expected 52.5. In terms of important sub-indices, the new orders index rose by 0.9 points to 52.2 in February, while the business activity index slightly decreased by 0.1 points to 54.4 in February, and the price index rose by 2.2 points to 62.6 in February, indicating a significant increase in prices.

(2) The unemployment rate in the U.S. rose in February 2025, and non-farm payroll growth fell short of expectations. The official unemployment rate for February, which measures the number of actively seeking unemployed individuals (U3 unemployment rate), is 4.1%, higher than the previous value of 4.0 and the expected 4.0. The U6 unemployment rate, including temporary workers, is higher than in January, indicating that the rise in the unemployment rate reflects a weak U.S. labor market, which somewhat corroborates the decline in the manufacturing PMI index in February In February, the U.S. non-farm payrolls increased by 151,000, falling short of the market expectation of 160,000, but higher than the previous value of 125,000. The largest contribution still came from the service sector, particularly education and healthcare services, which contributed nearly 50% of the new jobs (+73,000).

(3) The Federal Reserve remains cautious, waiting for a clearer economic outlook. On March 7, Federal Reserve Chairman Jerome Powell stated that there is no need to rush to adjust the policy interest rate at this stage, and the Fed can patiently wait for the situation to become clearer, emphasizing that the cost of maintaining caution is very, very low. He highlighted that the uncertainty brought about by changes in Trump’s policies remains relatively high. The Fed is assessing the impact of changes in trade policy, which have exacerbated economic uncertainty. The current focus of the Fed is to distinguish between real signals and market noise during the process of changes in the economic outlook. As of March 9, Fedwatch predicts a 12.0% probability of a 25bp rate cut in March 2025, up from 7.0% last week; the likelihood of a rate cut in May is 52.1%, up from 32.0% last week; and the probability of another rate cut in June, following the May cut, is 38.6%, up from 23.8% last week.


Author of this article: Li Yong, source: Li Yong Macro Bond Research, original title: "Zhou Guan: Has the 'Early Start' Interest Rate Cut Expectation Been Restored?"

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