The US Treasury is spending money "without closing the door", be cautious when trading interest rate cuts

Recently, with the expectation of a rate cut in the US stock market and the trade expansion of a soft landing of the US economy, especially last week when the CPI directly caused the market to boil over - the traditional cyclical index Dow Jones was sluggish, while the Nasdaq once again rallied under the drive of AI (strong performance of downstream applications Oracle + Adobe).

However, as mentioned in last week's strategy weekly report by Dolphin, whether the rate cut can really materialize still depends on whether the fiscal policy of the US federal government can converge. Just last week, both the CPI and federal fiscal support were released. Dolphin will combine these two important macroeconomic data along with recent commercial bank credit data to see if the rate cut expectations can truly become a reality.

I. Will Service Inflation Also Cool Down? Limited Credibility of Monthly CPI

The May CPI data did perform well, and all the surprises can be summarized in the following charts:

First: The "cooling down" of the seasonally adjusted core service month-on-month - in May, the month-on-month rate fell to 0.2% for the first time.

Second: After excluding housing costs, the month-on-month core service dropped from 0.8% in March to zero growth in May.

Third: Further breaking down the sub-items, behind the zero growth in the core service excluding housing costs is the roller-coaster-like increase in car insurance prices in transportation costs, which rapidly slowed down to contraction in May, while service items with heavier labor cost elements, such as lawn care, garbage collection, and other personal services, all turned into negative growth month-on-month.

In other words, the information truly revealed by this CPI this time is not only the usual leakage of commodity prices and the well-known decline in oil prices, but also a sign of the slowdown in prices of the most stubborn core human service types in this wave of inflationHowever, the main problem here is that when CPI data is viewed on a monthly basis without being integrated with other data, the confusion is too great. But when we focus on the May labor report, we can see that under the tight demand for white-collar positions, the average monthly salary for the whole society has accelerated growth compared to the previous month, and the average monthly wage growth since the beginning of the year is not low.

So, can the downward trend of inflation this time truly be maintained? Let's take a look at it again, combined with the May level of US federal fiscal expenditure and the changes in the credit growth rate of the US commercial banking system.

II. May: Fiscal Spending is Still Lavish

The latest data on US federal fiscal revenue and expenditure for May seems like Biden is "spending money like crazy" again, just after the fiscal surplus brought by the April tax season, May brought a deficit of nearly $350 billion.

However, a large portion of the payments were due to the fact that the first two days of June this year fell on a weekend, so the payments were scheduled for the last day of May. If we exclude the timing difference, the actual deficit in May this year is $255 billion. After adjustments, compared to the average monthly deficit of around $150 billion last year, and the nearly $190 billion deficit in the first three months of this year, it is still significantly higher.

Specifically, how was this deficit generated? The biggest feature on the revenue side is the "huge" increase in corporate tax revenue:

Following the significant year-on-year increase in personal income tax in April with the help of asset gains, corporate income tax revenue, which contributes over 20% of federal fiscal revenue, more than doubled year-on-year in May. It has become the single largest category contributing to fiscal revenue growth.

Looking at April and May together, a very clear picture of 2024 has emerged: the government's taxation on residents and enterprises seems to have significantly increased. As of May, personal income tax revenue has accumulated a year-on-year growth of 13%, and corporate tax revenue has accumulated a year-on-year growth of 25%, significantly exceeding the nominal GDP growth rate.

However, even with increased revenue, the increase in fiscal expenditure is higher, leading to a widening of the fiscal deficit in May compared to last year's already high absolute value.

Interest payments, Medicare expenditures for individuals over 65, and Social Security retirement benefits for retirees are fixed passive items that cannot be contained in an aging and high-interest rate environment. The more prominent additions in May are mainly the significant year-on-year increase in defense spending and benefits for veterans, leading to a noticeable deficit.

And the deficit in the first five months of this year has also decreased by $50 billion compared to the same period last year. If calculated according to the fiscal year starting in October last year by the U.S. Department of the Treasury, the 2024 fiscal year has passed eight months, but the actual deficit has not decreased at all compared to the same period last year. The U.S. fiscal target is to reduce the deficit from $1.7 trillion in 2023 to $1.5 trillion in 2024.

Overall, up to now, whether it is the increased fiscal transfers or the continuous deficit, the U.S. government is still actively using fiscal policy to offset the impact of high interest rates on the economy.

III. The Fed Guides Hawkish, Private Credit Weakens

Compared to the U.S. federal government continuously borrowing money to boost the economy regardless of interest rates, the sensitivity of businesses and residents reflected in the balance sheets of U.S. commercial banks to interest rates and interest rate expectations is much higher.

Dolphin divided the asset side of U.S. commercial banks' balance sheets into three periods for comparison:

a. Hawkish rate hikes in 2023: In 2023, when nominal interest rates and interest rate expectations kept rising, the asset expansion of U.S. commercial banks was very slow, traditional commercial loans were in negative growth, and consumer loans to C grew by only 3.3%.

b. First quarter of 2024: The Fed suddenly shifted, effectively capping interest rates, while guiding expectations for rate cuts in 2024. The result was a marginal increase in loans to both businesses and residents, with a CPI rebound under loan repair.

c. Second quarter of 2024: In the latter half of March, the Fed began to guide a return to high interest rates. As a result, data on loans to residents (consumer and real estate mortgage loan growth rates rapidly declined), but the loan growth rate for businesses that performed well in the previous year's EPS continued to accelerate repair. However, the main battlefield for corporate financing in the U.S. is the stock market, not banks, so the growth of corporate loans on bank balance sheets does not affect the overall decline in loan growth rate.

And if we put together the information from , there is a very clear signal:

a. Fiscal easing has not significantly converged: The U.S. federal government's pro-cyclical efforts to stimulate the economy have not significantly converged, at most offsetting some high expenditures through increased taxes on residents/businesses and higher transfer payments. Strong fiscal stimulus will continue to offset the impact of high interest rates.

b. Variables have shifted to monetary policy: In a situation of continued fiscal easing, intermittent consumer spending exceeding income growth, if monetary policy also enters a loosening cycle, then the U.S. economy will become a situation of pro-cyclical fiscal and monetary easing, which can only be described as "adding fuel to the fire," and inflation is unlikely to truly decline.

Especially, from a quantitative perspective, quantitative tightening has substantially slowed down, with monthly bond sales reduced from $60 billion starting in June to $25 billion. From a qualitative perspective, whether the Fed guides market expectations for rate cuts without controlling the timing and extent of rate cuts, it may ultimately prolong the U.S. economy's entry into a rate-cutting cycleTherefore, in the current situation, as to whether the Federal Reserve can truly start a rate-cutting cycle, Dolphin believes that besides the outcome-oriented CPI data, what is more important is the marginal changes in household consumption under the stable high employment situation, as well as the changes in government fiscal behavior.

If both households and the government continue to spend vigorously, and the corporate sector is already in a cycle of expanding capital expenditure driven by new technologies such as AI, it is feared that the Fed's only choice will be to maintain high interest rates.

Up to now, household consumption has been affected by asset inflation in a high-interest environment, income polarization, and a possible slowdown in the decline of the savings rate. However, the government's fiscal policy still seems relatively aggressive. From this perspective, Dolphin believes that it is not rational to chase after equity assets when the market's rate-cutting expectations are quite sufficient.

In addition, the domestic consumption trend can be observed through Dolphin's latest analysis of social retail 《May Social Retail Review: How is consumption getting worse before the 618 mid-term exam?》

IV. Portfolio Rebalancing and Returns

Dolphin did not rebalance the portfolio before the Dragon Boat Festival. At the end of last week, the portfolio's return increased by 0.4%, underperforming the S&P 500 Index (+1.6%), but outperforming MSCI China (-1.4%), Hang Seng Tech Index (-1.7%), and CSI 300 (-0.9%).

Since the start of the portfolio testing until the end of last week, the absolute return of the portfolio is 36%, with an excess return compared to MSCI China of 55%. From the perspective of asset net value, Dolphin's initial virtual assets of $100 million have now risen to $138 million.

V. Individual Stock Profit and Loss Contribution

Last week's high gains were mainly driven by US stocks, with significant contributions from TSMC and Facebook. In addition, Chinese concept stocks like Bilibili had some independent market movements due to new games. Alibaba performed weakly due to weak fundamentals and poor performance in convertible bond issuance. Furthermore, consumer stocks such as Moutai, Huazhu, Nongfu Spring, etc., have been declining recently due to Moutai's price cuts, and hotel ADRs have been continuously declining, showing relatively weak performance.

The overall trend last week was clear: US stocks led the rise, while Chinese concept stocks showed a more differentiated upward trend, with only Chinese companies with strong fundamentals or improving margins likely to hold up. Consumer goods stocks, on the other hand, have been falling due to Moutai's price cuts, with stock prices declining across the boardSix. Distribution of Portfolio Assets

The Alpha Dolphin virtual portfolio holds a total of 20 individual stocks and equity-type ETFs, with 5 core holdings and the rest of the equity assets being underweighted, with the remaining allocation in gold, US bonds, and US dollar cash.

As of last weekend, the asset allocation and equity asset weighting of Alpha Dolphin are as follows: