Market Pricing of Debt Crisis: Economic Outlook from Rising Term Premium

Recently, the cryptocurrency market has experienced significant fluctuations, showing an M-shaped pattern in prices. With the new government about to take office, the capital market has begun to assess related opportunities and risks, marking the end of the past three months of emotion-driven market trends. Amid the complex and varied information, we need to identify the focal points of short-term market speculation in order to make rational judgments on market changes.

Overall, high-growth risk assets, including the cryptocurrency market, may continue to be under pressure in the short term. This is mainly due to the widening term premium in the U.S. Treasury market, which has led to higher medium- to long-term interest rates, adversely affecting these assets. The fundamental reason for this situation is that the market is pricing in risks associated with a potential U.S. debt crisis.

Macroeconomic indicators remain strong

From the recently released important macroeconomic indicators, the US economy remains in good shape. The ISM manufacturing and non-manufacturing Purchasing Manager's Index continue to rise, suggesting a relatively optimistic outlook for the US economy in the short term.

In terms of the labor market, non-farm payrolls increased by 256,000, exceeding expectations. The unemployment rate fell to 4.1%, and JOLTS job openings surged to 809,000. The number of initial jobless claims continued to decline, indicating a promising labor market performance in January. These data suggest that the U.S. labor market remains strong, and an economic soft landing seems almost certain.

In terms of inflation, the University of Michigan's 1-year inflation expectation in the United States has slightly risen to 2.8%, but it remains within a reasonable range. From the changes in the yields of inflation-protected securities (TIPS), the market does not seem overly concerned about inflation.

In summary, from a macro perspective, there are no obvious issues in the U.S. economy. So, what is the core reason for the decline in valuations of high-growth companies?

The long-term interest rates of US Treasuries continue to rise

The yield curve of U.S. Treasury bonds shows that long-term rates continued to rise over the past week, with the yield on 10-year Treasury bonds climbing by about 20 basis points, further exacerbating the bear steepening pattern. The rise in Treasury yields typically has a more negative impact on high-growth stocks than on blue-chip or value stocks, primarily due to the following reasons:

1. Rising financing costs affect business expansion.
2. The increase in the discount rate of future cash flows lowers the valuation.
3. Investor preferences may shift towards more robust value stocks.
4. May lead to companies reducing R&D and expansion expenditures

In contrast, stable enterprises are relatively less affected, mainly due to their strong profitability, stable cash flow, and lower reliance on external financing.

The rise in term premium reflects concerns over debt crisis

The nominal interest rate of government bonds can be decomposed into three parts: the real interest rate, inflation expectations, and the term premium. The previous analysis indicates that there have been no significant changes in real interest rates and inflation expectations in the short term. Therefore, the main factor driving the rise in nominal interest rates is the term premium.

Observing the estimated term premium level of U.S. Treasury bonds based on the ACM model, it can be seen that the term premium for 10-year Treasury bonds has recently risen significantly. However, the Merrill U.S. Treasury volatility index (MOVE) has not shown drastic changes, indicating that the market is not sensitive to the volatility risk of short-term interest rates.

This indicates that the market has not yet priced in significant risks regarding potential policy changes by the Federal Reserve. However, the continued rise in term premiums reflects the market's concerns about the medium to long-term economic development in the United States, primarily focusing on the issue of fiscal deficits.

It can therefore be inferred that the market is pricing in the potential debt crisis risk in the United States following the new government's assumption of office. In the near future, paying attention to policy information and various viewpoints on the impact of debt risks will help in assessing the trends in the risk asset market.

It is worth noting the progress of the tax reduction policy and how to cut government spending, which will be the most important focus in the entire market game.