Song Xuetao: What are U.S. stocks, U.S. bonds, and the U.S. dollar pricing respectively?

From the perspective of time dimension and substitutability, the current U.S. stocks, U.S. bonds, and the U.S. dollar are gradually diverging. The time dimension for dollar pricing is the longest, U.S. stocks the shortest, and U.S. bonds are in between; while the substitutability of U.S. stocks is relatively low, the substitutability of the dollar is relatively high, and U.S. bonds are also in the middle.

The fundamental reason is that the core drivers of the three differ. Currently, U.S. stocks are driven by short-term sentiment and capital; U.S. bonds are intertwined with short-term recession expectations and long-term fiscal sustainability concerns; the dollar reflects medium-term tariff factors and long-term fiscal sustainability worries.

U.S. Stocks: The Shortest Pricing Time Dimension, Currently Driven by Sentiment and Capital

Firstly, U.S. stocks are becoming more short-term and retail-oriented; before the equal tariffs in early April, Trump's reverse policy expectations (strong anti-immigration, DOGE reforms) significantly impacted the economy, while tariff expectations reinforced market shocks. The rebound after April was mainly driven by sentiment and capital: retail investors became the main force, with speculative psychology dominating.

Short-term positives include the continued promotion of tax cuts, easing fiscal contraction (such as Musk leaving DOGE), and the alleviation of tariff shocks (only retaining a 10% baseline tax and a 90-day easing period). On this basis, Wall Street's "TACO" mentality boosts short-term sentiment; however, the sustainability of these factors has not been significantly recognized.

Secondly, the issues undermining the foundation of U.S. stocks have not been resolved. AI Narrative Undermined: The update of foundational models has slowed, with capability improvements and commercialization processes extended. Wealth Gap Continues to Widen: The structure of U.S. stock increases is diverging, with tariffs (poor tax) and tax cuts (rich tax) potentially exacerbating the wealth gap and political trust issues in the U.S. Fiscal Issues Persist: The rolling deficit rate has not significantly contracted, which is a short-term positive for U.S. stocks but a long-term negative for dollar assets; at the same time, foreign investors also need to consider additional foreign exchange losses.

U.S. Bonds: Moderate Pricing Time Dimension, Intertwined Short-Term Economic Recession and Long-Term Fiscal Sustainability Concerns

The pricing time dimension of U.S. bonds is more complex, with both short-term and long-term pricing coexisting. The short end (1-10 years) prices more for recession and interest rate cut expectations, while the long end (10-30 years) prices more for long-term fiscal sustainability concerns and the impact of tariffs on dollar credit. After the inversion is lifted in September 2024 (2s10s), the U.S. bond yield curve began to steepen, with a more pronounced decline in the middle section

First of all, in the short term, signs of a weakening U.S. economy are becoming increasingly clear, with the overdraw effect of consumer spending further manifesting. More and more data from the U.S. is sounding the "alarm," such as the number of continuing unemployment claims being significantly higher than our set deviation value of 5%, indicating that pressure on the labor market will increase.

At the same time, the May PCE data reflects a further weakening of the income and expenditure structure: May's real spending contracted by 0.3% month-on-month, and real income contracted by 0.4% month-on-month. The importance of income and expenditure data far exceeds that of the core PCE inflation slightly exceeding expectations. If income declines, spending will naturally decline, and without demand, there is no need to worry about inflation in the short term.

The decline in inflation and weakening data create conditions for the Federal Reserve to cut interest rates, and short-term U.S. Treasury yields may further decline.

Meanwhile, the sustainability of U.S. fiscal policy has not been resolved. The latest OBBB bill (Senate version as of June 30) does not significantly focus on spending (deficit reduction) but rather further demonstrates the Senate's dovish stance on fiscal matters. According to the latest estimates from the Committee for a Responsible Federal Budget (CRFB), the Senate reconciliation bill is expected to increase the deficit by approximately $3.5 trillion to $4.2 trillion over the next decade, nearly $1 trillion more than the version passed by the House of Representatives.

As of now, the terms announced face considerable uncertainty due to constraints from the Byrd Rule, and projections suggest that the debt-to-GDP ratio will reach around 125% by 2034, significantly higher than the current baseline scenario of about 117%. Although there will be many adjustments in the future, the current further dovish evolution does not help alleviate fiscal concerns.

U.S. Dollar: Longest Pricing Time Dimension, but "Credit Damage" Difficult to Quantify

The U.S. dollar has fallen about 10% compared to the beginning of the year, with pricing reflecting a combination of mid-term tariff factors and long-term fiscal sustainability leading to credit damage.

Regarding tariff threats, we believe they may gradually weaken around August. Since the implementation of reciprocal tariffs, Trump has used the dollar and U.S. Treasury bonds as tools for tariff negotiation threats, putting pressure on the dollar (especially against Asian currencies). Negotiation expectations have triggered widespread appreciation of non-U.S. currencies and a reduction in dollar assets. It is expected that the tariff threat may weaken around August as a negotiation framework is reached, providing a potential turning point for the dollar.

However, the judgment on the long-term sustainability of fiscal policy is quite complex, involving both subjective factors (Trump's debt monetization methods) and objective factors (U.S. competitiveness).

The subjective factor is that Trump is exacerbating the contradictions regarding the long-term sustainability of U.S. debt; while the objective factors are more reflected in the ongoing questioning of the foundations of the U.S. dollar (values, technological and military advantages, etc.). Recent geopolitical events (such as the conflict with Iran) have exposed uncertainties in U.S. strength and intervention dilemmas, raising concerns that unfavorable outcomes could further damage the credibility of the dollar.

The market's expectations for a weaker dollar are converging, with differences in duration and magnitude: some are bearish in the long term (looking at 70-75), believing that Trump is unable to resolve fiscal issues and will revert to the old path of deficit monetization, but the credit issue is difficult to quantify clearly. At the same time, it cannot be ignored that if Trump continues with deficit monetization, the resilience of the U.S. economic fundamentals will become a natural counterforce to a weaker dollar.

Another reason for the divergence in pricing of U.S. stocks, U.S. bonds, and the dollar is the difference in substitutability.

The substitutability of U.S. stocks is relatively low, with much of the recent capital purchasing U.S. stocks coming from American retail investors. From a global perspective, many companies listed in U.S. stocks still demonstrate strong profitability and growth rates.

Although U.S. stock valuations still appear expensive from the perspective of Shiller PE, the "muscle memory" built over decades means that U.S. stock investors do not deliberately focus on valuation issues. That is, the valuation itself is not concerning; what is worrying is the lack of sustainability in company growth or the increasing uncertainty in the overall economic environment, which is precisely what U.S. stocks have not experienced for many years but are currently undergoing.

In the short term, investors find it difficult to identify other companies that can be fully substituted. For example, it is hard to find similar emerging growth companies in Japan and Europe; only in China, particularly in the Hong Kong stock market, can some "new money" be found; however, in terms of scale and familiarity with the market/assets, it is still hard to compete with U.S. stocks.

U.S. bonds have a certain degree of substitutability. Long-term U.S. bonds can be substituted with short-term U.S. bonds, and short-term U.S. bonds can also be substituted with Japanese bonds, German bonds, gold, or other cash-like assets, so there are relatively many substitutes for U.S. bonds.

From the perspective of duration, the interest rates on relatively short-term U.S. bonds are declining, and the market's concern about problems with short-term U.S. bonds is relatively low; however, long-term U.S. bond rates face many upward catalysts, and the cost-effectiveness may be relatively limited, requiring investors to bear greater volatility.

There are more alternative choices for the dollar; when overseas holders expect the dollar to weaken in the long term, they are more likely to turn to other currencies (such as the renminbi, euro) or commodities (such as gold).

Rejecting linear extrapolation, the consensus expectations of TACO are fragile.

From the perspective of political economy, the current market consensus expectations are fragile, and linear extrapolation may lead to erroneous conclusions.

For U.S. stocks, Trump's retreat (TACO) is only based on a "worst-case scenario" at a certain moment, which does not mean that the harm to the economy has not occurred, and as time progresses, the threshold for this "worst-case scenario" becomes lower and closer to the margin of "failure." Indeed, the policies we have seen so far (tariffs, immigration, etc.) will not directly trigger a recession, but that boundary is not far off; any escalation of tariffs, deterioration of geopolitical conditions, or even an increase in chaos surrounding illegal immigration in the United States could very likely break this thin veneer. In addition, we cannot underestimate Trump's long-term commitment to reducing debt, lowering deficits, and decreasing interest burdens; if medium to long-term economic expectations worsen, U.S. stocks will be the first to bear the brunt.

The U.S. dollar needs to be viewed more comprehensively; currently, Trump's control over different policies shows variation, and he also exhibits clear subjective preferences: for example, accelerating the pace of U.S.-China negotiations, which pressures other negotiation processes (significant progress has been made on issues related to Canada and Europe), while other external issues have been somewhat shelved.

Therefore, overseas investors still need to seek protection for their existing positions, which will be reflected in the continued trend of a weakening dollar. Until the issues where Trump's control is waning become clearer, funds will continue to avoid risks in the most prudent manner (directly selling U.S. assets to reduce exposure), although the short-term slope may slow down.

In the short term, due to weakening economic data, rising expectations of recession and interest rate cuts, and narrowing interest rate spreads, the dollar may decline to around 95; however, the long-term trend (such as down to 70-80) still requires continuous observation from a political economy perspective. The current view of a medium to long-term weakening dollar is based on pessimistic expectations regarding Trump's policy outlook (abandoning reforms and returning to deficit monetization). However, Trump still has a long term in office, and there is time and space for action before the midterm elections. It is difficult to assert that the dollar will continuously depreciate in the long term or that its credit will be continuously damaged.

The trading value of U.S. Treasuries still outweighs their allocation attributes, and the asymmetry of volatility will intensify. Fiscal/debt sustainability is a slow variable, while the weakening of hard data (growth concerns) is relatively fast, which means that U.S. Treasury rates are likely to show a pattern of "slow rise and rapid fall." In the long term, the fiscal bills in the Senate (including the House of Representatives) still adhere to the principle of "enjoying today without worrying about tomorrow," leaving problems for later until small issues become big problems.

Authors of this article: Song Xuetao, Zhong Tian, Source: Xuetao Macro Diary, Original title: "Song Xuetao: What are U.S. stocks, U.S. Treasuries, and the U.S. dollar pricing respectively?"

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