Shenwan Hongyuan: US Bond Panic Returns - What Has the Market Misread?

Shenwan Hongyuan Group Co., Ltd. released a research report stating that on January 20, overseas markets once again experienced a "triple sell-off" in stocks, bonds, and currencies. The market often mistakenly believes that debt expansion will lead to a collapse of US and Japanese debt, potentially triggering a debt default risk in the future. However, for developed sovereign currency nations, central banks possess nearly unlimited capacity to issue their own currency, making the possibility of a substantive default relatively low. Debt crises in emerging markets often manifest as credit risk, whereas in developed nations with sovereign currencies, they typically present as currency depreciation and rising inflation expectations. Shenwan Hongyuan's main views are as follows: Under the impact of the US triple sell-off, Trump once again employed TACO, withdrawing proposed tariffs on Europe. Although the short-term market shock has temporarily eased, fundamental conflicts such as debt and geopolitics remain unresolved. As debt continues to expand, Trump is likely to adopt more "flexible" financial repression measures. First, Hot Topic Analysis: The Return of US Bond Panic - What Has the Market Misread? (1) Global Bond Market Panic Returns, US Experiences "Triple Sell-off," Trump Again Employs TACO On January 20, overseas markets once again experienced a "triple sell-off." US, European, and Japanese government bonds were collectively sold off, risk assets like equities fell broadly, the US dollar weakened, and safe-haven assets like gold strengthened. Japan's 40-year government bond yield broke above 4.0%, the 10-year US Treasury yield rose to 4.3%, the 30-year UK gilt yield climbed to 5.2%, the US dollar index fell to 98.54, the Nasdaq dropped 2.39%, and gold rose to $4748 per ounce. Three core factors triggered the triple sell-off. First, the US-Europe Greenland dispute sparked market concerns about tariffs; second, a Danish pension fund announced it would exit US Treasury investments, raising fears that Europe might "weaponize" US bonds, increasing selling risks; third, Japanese Minister Sanae Takaichi announced on January 19 the dissolution of parliament for a snap election, and a weak Japanese government bond auction on January 20 exacerbated the sell-off in US Treasuries. Under this liquidity shock, Trump again used TACO at the Davos Forum, leading to a temporary market easing. On January 21, US President Trump stated at the Davos Forum: 1) Ruling out the possibility of using force to seize Greenland; 2) Having formed a framework agreement with Europe on Greenland; 3) Tariffs would not be imposed on February 1. These remarks eased market concerns about geopolitics and tariffs, leading to a temporary recovery in US stocks, bonds, and the dollar. (2) Short-Term Shock Eases, But US Long-Term Fundamental Conflicts Unresolved; Debt Expansion, Tariff Risks May Become Normalized The US fiscal deficit is likely to continue rising. Marked by the 2025 "Beautiful Big Act," US fiscal expansion is no longer triggered solely by recession. In 2026, the US plans both tax cuts to stimulate demand and increased supply-side investment. The scale of tax cuts in 2026 might increase by 40%, the deficit-to-GDP ratio could rise to 6.8%, defense spending may increase by 10%, and spending on immigration enforcement and borders might surge by 60%, suggesting US debt risks may become more常态化 (normalized). The political impetus for active fiscal tightening from both US parties has weakened. Firstly, supply-side investments in areas like defense and AI are long-term, spanning multiple years and difficult to wind down quickly; secondly, influenced by the political cycle, spending may continue to increase, with the average deficit ratio in US election years being 10.2% higher than in non-election years; thirdly, a consensus on fiscal expansion has formed between the parties, differing mainly in direction. Even if Trump loses the election, the US deficit may still rise. Tariff risks and geopolitical risks instigated by the US are likely to persist long-term. Even if reciprocal tariffs are ruled illegal, Trump could use alternative measures like Section 232 tariffs. Marked by events like the Venezuela incident and reciprocal tariffs, Trump's disruption of the post-WWII international order is deepening. This trend may not end with Trump's term, as geopolitical risks shift from a macro variable to a macro constant, making US bonds less safe. (3) Looking Ahead, Trump May Adopt "Structural" Financial Repression to Lower Real Rates, But Don't Expect YCC from the Fed The market often misreads that debt expansion will lead to a US or Japanese debt collapse and a potential default risk. However, for developed sovereign currency nations, central banks' near-unlimited currency issuance capacity makes substantive default unlikely. Debt crises in emerging markets often manifest as credit risk, whereas in developed sovereign currency nations, they typically appear as currency depreciation and rising inflation expectations. To mitigate debt risks, Trump may adopt "structural" financial repression measures to lower real interest rates. The pace of Trump's fiscal consolidation is already insufficient to alleviate market concerns. Potential US measures include: government involvement in interest rate forward guidance; expanding the Treasury's liquidity回购工具 (repo facility); adjusting the maturity structure of debt issuance to reduce long-end impact; relaxing the SLR (Supplementary Leverage Ratio); reforming loan interest rate pricing, etc. In a state without war or zero interest rates, it is highly unlikely the Fed would use QE or YCC (Yield Curve Control) to suppress US Treasury yields. Excluding wartime periods, the historical experience of global central banks is that zero interest rates are a prerequisite for QE or YCC. The underlying logic is that the goal of QE or YCC is to lower long-term rates, and the most effective way to achieve this is to first cut rates to zero (or negative). Risk Warning Geopolitical conflicts escalate; US economic slowdown exceeds expectations; Federal Reserve turns more hawkish than expected.