To The Moon

As the benchmark interest rate of the global market, 10-year US Treasury bond rate hit a low of only 0.5% in 2020, but now has broken through 4.6%. Has the US already entered a high interest rate era? $iShares 20+ Year Treasury Bond ETF(TLT)$ $iShares 0-3 Month Treasury Bond ETF(SGOV)$

A high interest rate era requires a significant increase in the central tendency of the US Treasury bond rate cycle. Based on existing data, although there is an upward risk to the central tendency of the US Treasury bond rate, the magnitude of the change may be limited and it may be premature to assert that we are returning to a high interest rate era like that of 1960-1980.

Currently, the 10-year US Treasury bond rate is at 4.608%, or at a high point in the inflation cycle, far above the central tendency. There is still a short-term risk of a rise in the 10-year US Treasury bond rate, it will be difficult to sustain above 4% in the long term and may experience a significant decline in the future.

The historical cyclical patterns and driving factors of the US Treasury bond rate: Since the 1960s, we can roughly divide the long-term trend of the US Treasury bond rate into three stages:

• The first stage is from 1960 to 1980, during which the US Treasury bond rate continued to rise, corresponding to the familiar "Great Inflation" era.

• The second stage is from 1980 to 2020, during which the US Treasury bond rate entered a long-term downward channel for nearly 40 years, corresponding to the "Great Moderation" era.

• After the COVID-19 pandemic, we entered the third stage, during which US inflation rose to 9%, reaching its highest level in the past 40 years, leading to aggressive tightening by the Federal Reserve and pushing the 10-year US Treasury bond rate back above 4%.

In summary, long-term inflation plays a decisive role in the long-term trend of the US Treasury bond rate; high inflation leads to high interest rates, while low inflation leads to low interest rates.

The above historical patterns are consistent with Fisher's classic theory: The 10-year US Treasury bond rate is a nominal interest rate that can be split into inflation expectations and real interest rates. Inflation expectations are influenced not only by current inflation levels but also by the inflation targets set by central banks. The real interest rate is influenced by short-term monetary policy but is determined by the natural economic growth rate in the long term. Since changes in inflation directly affect the inflation expectations component of the US Treasury bond rate, it is easy to understand why long-term inflation plays a decisive role in interest rate trends. Whether there will be a change in the central tendency of the US Treasury bond rate depends on whether there is a change in the central tendency of inflation and real interest rates.

The surge in post-pandemic inflation is mainly influenced by short-term factors, and it remains to be seen how much inflation will increase in the long term. From 2020 to 2022, US inflation soared from 0.1% to 9.1% in just two years. However, since June 2022, US inflation has returned to around 3% in just one year and is not far from the pre-pandemic central tendency of 2%. This indicates that long-term structural factors such as deglobalization, green transformation, and aging populations are not the main drivers of this round of inflation fluctuations.

Short-term factors such as supply chain mismatches and unprecedented government stimulus policies are the main drivers of this huge fluctuation in US inflation. Although long-term structural factors are not the main cause of this round of inflation, it is still possible that they will affect future central tendencies. We have found that these long-term factors have a high degree of uncertainty in their impact on inflation and there is still much debate about their mechanisms of influence. It is difficult to determine whether there will be a significant increase in inflation central tendency before obtaining more data.

There is not enough evidence for a significant increase in the central tendency of real interest rates. From a long-term perspective, the central tendency of real interest rates is the natural interest rate, reflecting potential economic growth rates and productivity. Considering the disturbance of economic production caused by the pandemic, it is difficult to imagine that economic production efficiency will increase rather than decrease after the pandemic.

One of the founders of the Federal Reserve's natural interest rate model and president of the New York Fed, Williams, re-estimated post-pandemic natural interest rates and potential growth rates in 2023, confirming that US potential output has clearly declined after the pandemic and that natural interest rates have not changed much relative to pre-pandemic levels, still slightly above 0%, with even further risks of falling to 0%.

From the perspective of natural interest rates, it seems that the US is still in a low-interest-rate era. Although the Federal Reserve can push real interest rates far above natural interest rates in the short term, it is difficult to maintain high real interest rates for a long time. We expect that the Federal Reserve will enter an interest rate cut cycle no later than 2024.

The US Treasury bond rate may not easily peak in the short term, but may experience a significant decline in the next 1-3 quarters. According to China International Capital Corporation's inflation model, US inflation may return to a range of 2.5%-3% as early as 2024. We estimate that inflation central tendency will reach a potential high point of 3% over the next year or two, while using 0% from the Federal Reserve's natural interest rate model as an estimate for real interest rate central tendency.

According to China International Capital Corporation's term premium model, US Treasury bond term premiums will be around 50bp over the next 1-2 years. Adding these three components together yields a central tendency for the 10-year US Treasury bond rate of about 3.5%. This central tendency is about 100bp higher than the average rate over the decade before COVID-19 but far from the historical range of high-interest-rate eras (4%-15%) like that of 1960-1980.

Currently, the 10-year US Treasury bond rate is at 4.608%, 100bp higher than its central tendency.

In the short term, there is still a possibility that US Treasury bond rates will rise further due to oil price risks, Federal Reserve tightening, and position sentiment factors. However, looking ahead to the next 1-3 quarters, we expect that it will be difficult for the 10-year US Treasury bond rate to remain above 4% for too long and that there may be significant downside potential. Accelerated global economic slowdowns, exposure of financial system risks, improvements in US inflation trends, and nearing completion of Federal Reserve rate hikes could all potentially catalyze declines in US Treasury bond rates.

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