【MACRO Insight】Financial markets in the vortex of US economic policy: the triple game of debt, curre

1. High debt and political game: a “stress test” of fiscal sustainability

The current debt interest expenditure has exceeded federal health insurance and defense spending. According to the forecast of the “Committee for a Responsible Federal Budget”, interest expenditure will reach 1 trillion US dollars next year, second only to social security as the largest expenditure item. The core of this change lies in the “inversion” of debt costs and economic growth - since the early 2000s, the inflation-adjusted 10-year U.S. Treasury yield has long been lower than the expected economic growth rate, and now both have risen to more than 2%, forming what Bernstein (former Biden economic adviser) calls a “game changer for debt sustainability.”

Behind the debt expansion is the continued expansion of policies. The Trump administration's tax cuts and spending bills and the Biden administration's expansionary fiscal plan have jointly pushed up the deficit. Goldman Sachs bluntly stated that “the current path is completely unsustainable”: the debt-to-GDP ratio is about to exceed the post-World War II peak, and the primary deficit is still far higher than the historical average during the economic boom. What's more difficult is that Trump's trade war and tariff policies have exacerbated this dilemma - high tariffs may suppress economic growth, push up inflation and interest rates, and further increase debt repayment costs, forming a vicious cycle of “tariffs-inflation-interest rates-debt”.

2. Monetary policy fog: the “expectation tug-of-war” between the Federal Reserve and the market

The Fed's policy path is becoming a core variable in market fluctuations. At the beginning of the year, traders were almost certain that interest rate cuts would resume in September, but strong employment data in July and uncertainty about tariff policies have reduced this probability from “a sure thing” to about 70%. The June CPI data has therefore become the “decisive factor” - Barclays pointed out that the June CPI has deviated from expectations by the largest margin in history. If it shows that price pressures are heating up (especially driven by Trump's tariffs), it may completely shake expectations of interest rate cuts and push up US bond yields; if the data is mild, it may restart easing bets.

There are also differences within the Fed: Powell emphasized the “moderately restrictive” interest rate stance, and the dot plot showed that there might be two rate cuts before the end of the year, but seven officials believed that there would be no rate cuts in 2025, and Waller and other directors hinted that rate cuts would be restarted as early as this month. This disagreement, combined with political pressure, has caused the U.S. bond market to fluctuate within a range - the two-year yield has fluctuated between 3.7% and 4%, and volatility has dropped to a three-year low.

三、Corporate earnings and the stock market paradox: differentiation and opportunities under low expectations

Compared with the cautiousness of the bond market, U.S. stocks hit a record high after the sell-off in April, but it is doubtful whether the “report card” of the second quarter earnings season can match the optimistic sentiment. According to Bloomberg Intelligence data, the profits of S&P 500 components in the second quarter are expected to grow by only 2.5%, the weakest performance since mid-2023. Among the 11 sectors, 6 are expected to see a decline in profits, and the full-year growth forecast has dropped from 9.4% in early April to 7.1%.

Market differentiation and external variables have exacerbated the complexity. The expected correlation of S&P 500 components in the next month is only 0.12 (only 3.2% of the time in the past 10 years is below this level), indicating that the performance of individual stocks is highly differentiated, and the importance of stock selection is highlighted. At the same time, the weakening of the US dollar (down 10% this year, the worst performance in the first half of the year since 1973) has become an “underestimated tailwind” for export companies, especially for large-cap stocks with a high proportion of overseas revenue; while European companies have continued to lower their earnings expectations due to tariff concerns and the strengthening of the euro (13% appreciation this year), and sectors such as automobiles and mining have been hit the hardest.

Conclusion: Reconstructing market logic in the policy vortex

The US financial market is experiencing “policy-driven” fluctuations: the steep upward channel of the ratio of debt interest to GDP makes interest rates the core node connecting fiscal and monetary risks. If the Fed succumbs to political pressure and cuts interest rates too early, it may push up long-term inflation and interest rates and increase the debt burden; if it insists on fighting inflation, it will directly amplify the pressure of interest expenditures.