CICC believes that the natural trend of the US fundamentals repair after the interest rate cut, combined with the incremental policy changes after the election, make it difficult for US bond yields to trend downward again, but it is also a trading and arbitrage opportunity.

Recently, the 10-year t-note has quickly risen to nearly 4.3%, increasing by 70 basis points from the bottom a month ago. Interestingly, on September 17th, when the Federal Reserve surprised the market with a 50 basis point rate cut while market expectations of rate cuts and recession were at their peak, looking back, it was actually the bottom of the interest rate. Here are a few points for everyone to consider.

Why the upward trend?

In fact, the upward trend is not surprising. We have been continuously reminding to think and act the opposite when it comes to rate cuts, and that rate cuts may also mark the gradual bottoming out of interest rates, similar to what happened in 2019. If you continue to put more on ​bonds expecting interest rates to fall during rate cuts, you are doing it wrong. In fact, over the past year, at almost any point in time, extrapolating market expectations of rate cuts linearly has almost always been incorrect.

There are three reasons:

One is excessive expectation overshoot; the second is the reflexivity of interest rates, where excessive rate cuts make it difficult for rates to fall further because lower financing costs are conducive to growth. When growth improves, naturally there is less need for rate cuts, similarly upward; the third reason is the increasingly strong influence from the recent Trump trade developments in the past few days.

How high will it go?

Another interesting point is that interest rates will overshoot both on the up and down sides and exceed expectations. Previously, the drop below 3.7% was also surprising. The central rate calculated by various methods such as the natural interest rate is 3.8-4%, but it cannot be guaranteed that it will immediately return once it exceeds this level. It's similar to how it continued to fall below 3.8% after breaking that barrier, as there have been too many occurrences of this over the past year.

What is the follow-up trend?

There should still be trading opportunities before the next rate cut, after all, interest rates that rise too high will also have a reflexive effect on the other side, and it is not likely that the rate will not be cut immediately (cme futures still pricing in a rate cut in November). However, it will be quite difficult to break through the previous lows. The natural trend of the U.S. fundamentals after the rate cut, combined with the incremental changes in policies after the election, make it difficult for the trend to decline again, but there are still trading and reflexive opportunities.

The timing and extent of the impact of the election are challenging.

After Trump's victory in 2016, rates surged by 80 basis points, but this time there are some precursors. If there is another significant surge after this election, it is recommended to go long for another wave. Then, as the fundamentals improve and the post-election policies become clearer, this round of downward cycle can come to an end.

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