The opening ceremony of the "Trump Market" has officially concluded: Observing how the market prices the "debt crisis" from the rise in term premiums

Author: ++@Web3_Mario++

Abstract: This week, the cryptocurrency market experienced significant volatility, with price movements forming an M-shaped pattern. These developments indicate that as Trump's inauguration on January 20 approaches, the capital market has quietly begun to price in the opportunities and risks associated with his election. This suggests that the three-month-long, sentiment-driven "Trump rally" has officially come to an end. Therefore, what we need to do now is to distill the focus of short-term market games from the myriad of chaotic information, which will help in making rational judgments about market changes. In this article, I will share my observational logic from the perspective of a non-financial professional enthusiast, hoping it can be helpful to everyone. Overall, I believe that many high-growth risk assets, including the cryptocurrency market, will continue to face downward pressure on prices in the short term. This is due to the widening term premium in the U.S. Treasury market and rising mid-to-long-term interest rates, which have adversely affected it. The reason for this situation is that the market is pricing in the U.S. debt crisis.

Macroeconomic indicators remain strong, and inflation expectations have not significantly intensified, thus having little impact on current price trends

First, let's look at the factors causing short-term price weakness. Last week, many important macroeconomic indicators were released, so let's examine them one by one. First, looking at the economic growth-related data from the U.S., both the ISM Manufacturing and Non-Manufacturing Purchasing Managers' Indexes have continued to rise. Since the Purchasing Managers' Index is usually a leading indicator of economic growth, this suggests a relatively positive outlook for the U.S. economy in the short term.

Next, let's examine the employment market. We will look at four data points: non-farm payrolls, job vacancies, unemployment rate, and initial jobless claims. First, non-farm payrolls increased from 212,000 last month to 256,000, far exceeding expectations, while the unemployment rate also fell from 4.2% to 4.1%. Additionally, JOLTS job vacancies saw a significant increase, reaching 809,000. Furthermore, initial jobless claims have continued to decline, indicating a positive outlook for the employment market in January. All of this suggests that the U.S. employment market remains strong, and a soft landing seems assured.

Finally, let's look at inflation performance. Since the December CPI will be released next week, we will observe the one-year inflation expectations from the University of Michigan. Compared to November, this indicator has seen a slight rebound to 2.8%, but it is still below expectations. This value seems to remain within the reasonable range of 2-3% defined by Powell. Of course, how this develops is still worth monitoring. However, from the changes in the yields of inflation-protected securities (TIPS), it appears that the market is not overly panicking about inflation.

In summary, I believe that from a macro perspective, there are no significant issues with the U.S. economy at present. Next, let's identify the core reasons for the decline in the market value of high-growth companies.

U.S. Treasury mid-to-long-term interest rates continue to rise, with a bear steepening pattern and a persistent increase in term premium, as the market prices in the U.S. debt crisis

Let's take a look at the changes in U.S. Treasury yields. From the yield curve, we can see that over the past week, long-term U.S. Treasury rates have continued to rise. For example, the yield on the 10-year Treasury bond surged by 20 basis points, indicating that the bear steepening pattern of U.S. Treasuries has further intensified. We know that the rise in Treasury yields has a more pronounced negative effect on high-growth stock prices compared to blue-chip or value stocks, primarily due to:

1. Impact on high-growth companies (typically tech companies and emerging industries):

   Rising financing costs: High-growth companies rely on external financing (equity or debt) to support business expansion. The rise in long-term rates increases the cost of debt financing, making equity financing more difficult as investors raise the discount rate on future cash flows.

   Valuation pressure: The valuation of growth companies heavily depends on future cash flows (FCF). An increase in long-term rates means a higher discount rate, leading to a decrease in the present value of future cash flows, thus lowering company valuations.

   Shift in market preference: Investors may shift from higher-risk growth stocks to more stable, dividend-paying value stocks, putting pressure on growth stock prices.

   Capital expenditure constraints: High financing costs may force companies to reduce R&D and expansion spending, affecting long-term growth potential.

2. Impact on stable companies (consumer, utilities, pharmaceuticals, etc.):

   Relatively mild impact: Stable companies typically have strong profitability and stable cash flows, with lower reliance on external financing, so rising rates have a smaller operational impact.

   Increased debt repayment pressure: If there is a high debt ratio, rising financing costs may increase financial expenses, but stable companies usually have stronger debt management capabilities.

   Decreased dividend attractiveness: The dividend yield of stable companies may compete with bond yields. When Treasury yields rise, investors may turn to higher-risk-free returns from bonds, putting pressure on stable company stock prices.

   Inflation transmission effect: If rising rates are accompanied by rising inflation, companies may face cost pressures, but stable companies typically have strong cost pass-through capabilities.

Therefore, it is evident that the rise in long-term Treasury rates has a significant impact on the market value of tech companies like cryptocurrencies. The key question now is to identify the core reasons for the rise in long-term Treasury rates in this context of interest rate cuts.

First, we need to introduce the nominal interest rate calculation model for Treasury bonds as follows:

I = r + π + RP

Where I represents the nominal interest rate of Treasury bonds, r is the real interest rate, π is the inflation expectation, and RP is the term premium. Here, it is necessary to elaborate a bit. The so-called real interest rate reflects the true return on bonds, unaffected by market risk preferences and risk compensation, directly reflecting the time value of money and economic growth potential. Meanwhile, π refers to the average inflation expectation in society, usually observed through CPI or the yields of TIPS. Finally, RP, the term premium, reflects the compensation investors require for interest rate risk. When investors perceive uncertainty in future economic development, they demand a higher risk premium.

In the analysis of the first part, we have clarified that the current U.S. economic development remains robust in the short term. Additionally, from the TIPS yields, we can observe that inflation expectations have not significantly risen. Therefore, real interest rates and inflation expectations are not the main factors driving the increase in nominal rates in the short term. Thus, the focus shifts to the factor of "term premium."

For observing the term premium, we choose two indicators. The first is the ACM model estimating the level of term premium in U.S. Treasuries. We can see that over the past period, the term premium for the 10-year U.S. Treasury has significantly increased, indicating that this factor is the primary reason for the rising U.S. Treasury yields. The second is the Bank of America Merrill Lynch Treasury Option Volatility, or the MOVE index. We can see that in recent times, volatility has not shown dramatic changes. Generally, the MOVE index is more sensitive to implied volatility in short-term rates due to its larger weight. From this data set, we can conclude that the market is currently not sensitive to short-term interest rate volatility. We know that short-term rates are mainly influenced by Federal Reserve decisions, so we can say that the market has not made significant risk pricing regarding potential policy changes from the Federal Reserve. Therefore, the recent panic triggered by changes in the Federal Reserve's interest rate decisions for 2025 is not a direct factor. However, the continuous rise in term premium indicates that the market is concerned about the medium-to-long-term economic development in the U.S., which clearly focuses on worries about the U.S. fiscal deficit issue.

Thus, it is clear that the market is currently pricing in the potential debt crisis risk in the U.S. following Trump's inauguration. Therefore, in the coming period, observing political information and the viewpoints of stakeholders is essential to consider whether their impact on debt risk is positive or negative, which will make it easier to judge the trends in the risk asset market. Taking last week's news of Trump considering declaring a national economic emergency as an example, entering a state of emergency allows for the implementation of new tariff plans under the International Economic Emergency Powers Act (IEEPA). This act unilaterally authorizes the president to manage imports during a national emergency. Therefore, the constraints and resistance to tariff adjustments will further diminish, undoubtedly amplifying concerns about the potential trade war impacts that had already eased. However, from the most direct impact, the increase in tariff revenue is undoubtedly a positive influence on U.S. fiscal revenue. Thus, I believe the resulting impact will not be very severe. Conversely, the progress of the tax reduction plan and how to cut government spending are the focal points worth paying attention to in the entire game, and I will continue to follow up.