In recent days, both US stocks and commodities have experienced a swift correction. This brings to mind a viewpoint that Western Securities Chief Analyst Cao Liulong has repeatedly presented during market roadshows, which many find quite unconventional. Against the backdrop of persistently high US Treasury yields and tightening liquidity, Cao suggests the Federal Reserve might actually restart quantitative easing (QE) in the second half of the year. This seemingly counter-intuitive judgment is built on a not-so-complex logical chain: if a bubble-bursting plunge were to truly occur in US tech stocks, the Fed might not only hesitate to raise rates but could even be forced to fire up the printing presses once more.
This perspective stands in stark contrast to the "rate cuts + balance sheet reduction" concept previously associated with Fed thinking and also diverges significantly from the current market expectation for rate hikes. To assess the potential validity of Cao Liulong's view, several key questions need addressing: What is the current state of US Treasuries and stocks? How severe is the tech stock bubble? And how much policy room does the Fed have left?
Underlying Liquidity Concerns Behind High US Treasury Yields
First, consider US Treasuries. As at the time of writing, the yield on the 10-year US Treasury note is at 4.5%, a relatively high level historically. Looking back over recent years, the 10-year yield hit a historic low of 0.52% during the initial pandemic phase in 2020, then climbed steadily as the Fed hiked rates and reduced its balance sheet, breaching the 4.4%-4.6% range during 2023-2024. While the current 4.5% level remains below the 2023 peak, it is notably above the median level of the past decade.
The direct consequence of elevated Treasury yields is liquidity tightening. Since the second half of 2025, signals of liquidity stress have intermittently appeared in the US money market. Abnormal volatility in short-term rates often indicates that bank system reserves are nearing a "scarce" threshold.
The Fed has indeed taken note of this issue. At its October 2025 FOMC meeting, the Fed announced it would halt its balance sheet reduction plan effective December 1 of that year, ceasing the runoff of its holdings of US Treasuries, agency debt, and MBS, as liquidity in the financial system was approaching the lower bound of ample levels.
However, stopping balance sheet runoff is not the same as restarting QE. Estimates suggest that the relative level of reserves in the US banking system remains above the "scarce" threshold, with projections indicating it may not fall below that level until the second half of 2027. This implies there is not a high immediate urgency for the Fed to proactively expand its balance sheet and restart QE.
The US Tech Sector: Gauging the Bubble's Severity
The crux of the issue lies with tech stocks. What is the probability of the assumption that US tech stocks experience a sustained, bubble-bursting crash?
From a macro logic standpoint, several clear risk points exist for tech stocks.
First is valuation running ahead of fundamentals. A significant portion of the Nasdaq's gains has been driven by earnings. If earnings growth fails to materialize as expected, a tech stock correction is indeed possible.
Second is interest rate sensitivity. Tech stocks, particularly growth-oriented ones, have valuations heavily reliant on discounting future cash flows. When the risk-free rate, represented by the 10-year Treasury yield, is high, valuation pressure on tech stocks increases significantly. The current 4.5% yield is certainly not favorable for highly-valued tech stocks.
Third is the uncertainty surrounding the AI investment cycle. It has been noted in various forums that AI is a strong deflationary force capable of boosting labor productivity, potentially enabling a "high growth + low inflation" scenario. This logic hinges on AI investments consistently generating returns. However, if the commercialization of AI falls short of expectations, or if a situation akin to the 2000 dot-com bubble burst occurs, the valuation correction for tech stocks could be severe.
Is the "Rate Cuts + Balance Sheet Reduction" Strategy Still Viable?
Next, consider the policy framework associated with recent Fed thinking. Its core proposed framework is a combination of "rate cuts + balance sheet reduction"—lowering the benchmark interest rate while contracting the balance sheet. This atypical path of "price easing and quantity tightening" is extremely rare in Fed history.
The logic is that balance sheet reduction tightens structural liquidity (the quantity of reserves), while rate cuts lower price-based funding costs (the interest rate level); the two are not contradictory. The aim would be to use "balance sheet reduction in exchange for policy space," simultaneously suppressing a source of inflation—balance sheet expansion—while stimulating real economy investment.
But this strategy has a critical prerequisite: markets must not experience a major crisis.
If tech stocks were to suffer a bubble-bursting crash, this framework would face severe challenges. The reason is simple: balance sheet reduction would further tighten liquidity, exacerbating market declines. While rate cuts could lower funding costs, during widespread market panic, rate cuts alone are often insufficient to stabilize markets.
Looking at history, during both the 2008 financial crisis and the 2020 pandemic shock, the Fed's choice was to restart QE, directly purchasing assets to inject liquidity into markets. The reason is that when systemic risk emerges, traditional interest rate tools become inadequate, and balance sheet expansion is necessary to repair market functioning.
What Would Trigger a Restart of QE?
So, under what conditions might the Fed actually restart QE?
Based on available information, several potential triggers exist:
First, a tech stock crash triggering systemic risk. If the Nasdaq index experiences a correction exceeding 20% that spreads to the entire financial system, causing credit markets to freeze and the banking system to come under pressure, the Fed would likely be forced to restart QE. This scenario would resemble the market crash in March 2020 at the pandemic's onset, when the Fed not only cut rates to zero but also launched unlimited QE.
Second, a renewed liquidity crisis. If money market rates persistently spike, with key rates like SOFR or LIBOR significantly deviating from the policy rate, it would indicate a severe shortage of bank reserves. A similar situation occurred in September 2019 when repo market rates briefly spiked to 10%, forcing the Fed to urgently intervene to provide liquidity.
Third, a sharp increase in recession risk. If a tech stock crash drags down the real economy, leading to a rapid rise in unemployment and a significant drop in consumption and investment, the Fed might be forced to use QE to stimulate the economy. While the proposed framework advocates stimulating the economy through rate cuts rather than balance sheet expansion, near the zero lower bound, QE might be the only option.
Implications for Debt Management
Another important dimension of Cao Liulong's viewpoint is that a Fed restart of QE could create policy space for large-scale debt management efforts. The logic is that if the Fed restarts QE, US dollar liquidity would flood markets again, potentially weakening the US dollar index and easing pressure on the Chinese yuan exchange rate, thereby granting Chinese monetary policy greater room to maneuver.
Historical experience shows that after the Fed restarted QE in 2020, global US dollar liquidity surged, capital inflows to emerging markets increased, and China entered a window of monetary policy easing. If a similar scenario replays, China could indeed gain greater policy space for debt management and stabilizing growth.
However, there is a timing issue. The prerequisite for the Fed restarting QE is a severe market or economic crisis in the US, and the crisis itself would impact global demand, potentially pressuring Chinese exports. Therefore, even if monetary policy space opens up, challenges facing the real economy would remain significant.
Investment Strategy Implications
So, how should one position investment strategies in response?
Based on the above analysis, several possible scenarios and corresponding investment strategies can be outlined:
Scenario One: Tech stocks achieve a soft landing while inflation recedes. Market expectations for rate hikes diminish, and the Fed pursues a "rate cuts + balance sheet reduction" strategy. In this environment, US dollar liquidity tightens marginally but not excessively, US stocks fluctuate with an upward bias, and capital outflow pressure on emerging markets is manageable. Investment strategies could focus on valuation recovery opportunities in A-shares and Hong Kong stocks.
Scenario Two: Tech stocks experience a significant correction, but the Fed does not restart QE. Market volatility increases under this scenario, but systemic risk does not yet materialize. The Fed might use verbal intervention or minor policy adjustments to stabilize markets. Investment strategies should reduce risk exposure and increase allocations to defensive assets.
Scenario Three: The tech stock bubble bursts, and the Fed restarts QE. This is the core scenario of Cao Liulong's viewpoint. Should this occur, the initial market reaction would be a panic-driven sell-off, followed by a rapid rebound once liquidity is injected. The investment strategy would involve adopting a contrarian approach to build positions in risk assets, especially growth stocks and emerging market assets that benefit from liquidity easing, once the panic subsides and the Fed truly launches QE. Commodity assets like gold and base metals would also likely bottom and recover.
In summary, Cao Liulong's view that "the Fed might restart QE," while seemingly unconventional, is actually based on a deep understanding of market fragility and policy constraints. If a tech stock bubble burst were to trigger systemic risk, the Fed might find itself with few alternatives, compelled to tread the familiar path of QE once more.
For investors, the key is not to predict which scenario will definitively occur, but to prepare through scenario analysis and contingency planning. Markets perpetually oscillate between expectations and reality, while policymakers constantly weigh ideals against constraints. Understanding this complexity is essential for finding opportunities within uncertainty.
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