When will U.S. stocks, U.S. bonds, and the U.S. dollar reach a turning point?

Core Viewpoint

Since 2024, U.S. Treasury bonds, U.S. stocks, and the U.S. dollar have shown significant pricing contradictions, providing unconventional pricing signals for a small cycle. To grasp the core logic of U.S. asset pricing, we can start from these three pairs of contradictions:

1. Inflation is falling, but U.S. Treasury yields have returned to high levels.

2. U.S. Treasury yields are at historical highs, yet U.S. stocks continue to rise strongly.

3. The interest rate cut cycle has begun, but the U.S. dollar index is rising against the trend.

These three sets of contradictions indicate that the market is pricing in a wave of industrial revolution driven by the U.S. AI technology boom.

The demand small cycle represented by inflation is declining, yet the industrial technology revolution is driving actual growth in the U.S., pushing up real interest rates and U.S. Treasury yields. Due to the technology wave, liquidity is tight (high U.S. Treasury yields), but U.S. stocks remain strong. Furthermore, as the U.S. is the leader in this technology wave, non-U.S. economies are weaker than the U.S., leading to an influx of international capital into the U.S. in pursuit of high returns from technology investments and the stock market, resulting in a stronger U.S. dollar index.

How will U.S. assets evolve in the future? The answer lies in the sustainability of the AI narrative.

Summary

At the beginning of 2025, the market's expectation for a decline in U.S. Treasury yields did not materialize. U.S. Treasury yields not only failed to decline but instead rose against the trend, leading to adjustments in U.S. stocks. The 10-year U.S. Treasury yield reached 4.7%, gradually approaching the highest point in five years. Alongside the continuously rising 10-year U.S. Treasury yield, the U.S. dollar index has also been climbing since January, nearing a reading of 110, setting a new high for the period.

The continuously rising U.S. dollar index has once again put pressure on non-U.S. currencies. Recently, the exchange rate of the U.S. dollar against the Chinese yuan has broken 7.3, reaching 7.33 last week. To address the pressure on the yuan against the dollar, the People's Bank of China is adjusting liquidity rhythms to balance interest rates and exchange rates, leading to fluctuations in stocks and bonds.

Why do these three sets of asset pricing—U.S. Treasury bonds, U.S. stocks, and the U.S. dollar index—continue to contradict general market expectations? What is the main logic behind U.S. asset pricing, and how should we grasp the main contradictions in U.S. asset pricing?

1. Unusual Pricing Contradictions of U.S. Assets Since 2024

We believe that after 2024, U.S. assets began to price in factors beyond the small cycle (credit and inventory cycles). To track the future trends of U.S. assets, it is essential to pay close attention to the driving forces beyond the small cycle. This judgment is made because, through the pricing of U.S. assets in 2024, we have captured three sets of pricing contradictions that differ from the small cycle patterns.

Contradiction One: Inflation and U.S. Treasury Yields Diverge. U.S. inflation has significantly declined, while U.S. Treasury yields have returned to high levels.

Although the decline in U.S. inflation in 2024 is not significant, it continues to trend downward. The year-on-year growth rate of core CPI fell from 3.9% in January to 3.3% in November, while the year-on-year growth rate of CPI dropped from 3.1% in January to 2.7% in November, gradually approaching the Federal Reserve's target.

However, in stark contrast to the inflation trend, U.S. Treasury yields at the end of 2024 are higher than at the beginning of the year. The Federal Reserve began its interest rate cut cycle in September, with the first cut of 50 basis points. Yet, U.S. Treasury yields shifted from a downward trend to an upward one, rising from a low of 3.6% in September to 4.5% in November After a slight pullback, U.S. Treasury yields in December rose again, essentially returning to the high of 4.7% before the interest rate cuts in early 2024, and this upward trend has continued into 2025.

Contradiction Two: Liquidity and U.S. Stocks Diverge. The U.S. liquidity environment is tight, yet U.S. stocks continue to rise strongly.

The 10-year U.S. Treasury yield has risen to the high levels before the interest rate cuts began in 2024, and currently, the Treasury yield is close to 4.8%, which is a historically rare high since 2001, indicating that U.S. liquidity conditions are tight.

However, contrary to the rising central tendency and absolute levels at historical highs of Treasury yields, U.S. stocks have continued to rise throughout 2024. The Nasdaq has performed particularly well, rising 29% for the entire year of 2024. In other words, U.S. stocks are continuously setting historical highs despite the relatively tight domestic financing rates.

Contradiction Three: Interest Rate Cuts and the U.S. Dollar Index Diverge. The U.S. has entered a rate-cutting cycle, yet the U.S. Dollar Index continues to rise.

Historically, when the U.S. enters a rate-cutting cycle, the U.S. Dollar Index generally weakens initially and then strengthens. Typically, interest rate cuts in the U.S. respond to a weakening U.S. economy, leading to a decline in the Dollar Index.

This round of the U.S. Dollar Index has shown anomalies. Since September 2024, despite the U.S. entering a rate-cutting cycle, the Dollar Index has risen significantly, breaking through the high point of 106 before the rate cuts in early 2024, reaching 108. While Treasury yields have not yet touched their annual highs, the Dollar Index has surpassed its high for 2024. Entering 2025, the Dollar Index continues to rise, peaking at 110, and after a slight pullback, it continues to rise, currently stabilizing at 109.

II. The "Asset Contradictions" Behind the New Economic Trends Driven by the Technology Wave

We will break down the three sets of contradictions in U.S. asset pricing to see if these contradictions reflect the same pricing logic.

The first set of divergence: The inflation central tendency and inflation expectations are declining, yet U.S. Treasury yields are rising, indicating that the actual growth central tendency of Treasury pricing is shifting upward.

The level of inflation is the result of fluctuations within the economic cycle. The continuous decline in inflation levels alongside rising Treasury yields indicates that real interest rates are being elevated. Observing the U.S. TIPS yields, we can see that the real yield on U.S. Treasuries has been rising since 2022, with recent data approaching pre-financial crisis levels.

There are three important reasons for the current U.S. economic growth: 1. The technology wave is driving growth in private investment, and technological diffusion is expected to enhance social productivity. 2. R&D investment is driving growth in private consumption. 3. The continuous rise in stock prices and housing prices is bringing about a wealth effect for households Risk appetite has increased, and risk assets such as Bitcoin and U.S. stocks have shown strong performance, while the stock-bond seesaw has kept U.S. Treasury yields at high levels.

The second divergence: strong U.S. stocks accompanied by high U.S. Treasury yields indicate that the pricing of U.S. stocks is driven not by the denominator (liquidity) but by the numerator (the technology wave).

In the past two years, U.S. liquidity has been tight, and the significant support for the rise in U.S. stocks has been the strong performance of technology stocks. The AI industry wave has driven growth in direct investments such as R&D and equipment, with Biden's three major acts directly promoting this process. Subsequently, the AI technology sector is expected to generate spillover effects, creating a multiplier effect for other industries, thereby boosting overall societal productivity. During Reagan's term, the development of personal computers produced both direct investment effects and indirect technology spillover effects.

The third divergence: a rate-cutting cycle corresponds with a strong dollar, indicating that international capital is pricing trends outside of the U.S. small cycle (inflation and rate cuts).

Generally, after the initiation of a U.S. rate-cutting cycle, the dollar index tends to decline. In this rate-cutting cycle so far, the Federal Reserve has cut rates by 100 basis points, yet the dollar index continues to strengthen. The key behind this is that the U.S. economy is performing better than some non-U.S. economies, while assets represented by U.S. stocks are performing strongly, leading to a continuous inflow of international funds into the U.S. The U.S. is the leader in this round of the AI technology wave. Driven by AI technology investments, private investment in the U.S. is robust, and U.S. technology stocks are performing strongly.

Starting from technology, we can understand the upward shift in the U.S. economic growth center, with U.S. Treasuries being pushed upward by real interest rates. It is precisely because of this round of technological wave that the U.S. can withstand the actual tight liquidity (high U.S. Treasury yields), while U.S. stocks remain strong. Moreover, because the U.S. is the leader in this round of technology, the technology effects in non-U.S. economies are weaker than in the U.S., leading to an influx of international capital into the U.S. in pursuit of high returns from technology investments and the stock market, resulting in a stronger dollar index.

III. How will U.S. stocks, U.S. Treasuries, and the dollar evolve in the future?

Since the unusual phenomenon of U.S. assets in 2024 tells us that the current pricing of U.S. assets is being driven by factors outside of normal inventory and credit cycles, namely a round of AI-driven industrial technological revolution. This scenario is very similar to the U.S. in the 1980s and 1990s.

To answer the future trends of U.S. stocks, U.S. Treasuries, and the dollar, we cannot avoid the sustainability of the industrial technological revolution driven by AI. At the very least, it depends on how long the market narrative around this round of AI industrial technological revolution can last.

U.S. stocks: The future strength depends on the sustainability of the technology driven by AI.

In 2024, U.S. technology stocks are expected to continue performing strongly, remaining the core driving force behind the growth of U.S. stocks. As we enter the second half of the year, with a phase of easing financial conditions and advancements in AI technology, U.S. stocks will be supported once again At the same time, the growth rate of construction spending in the high-end manufacturing sector in the United States continues to significantly outpace the growth rate of equipment investment. Whether equipment investment can achieve sustained growth in the future mainly depends on the development trends in the technology sector.

U.S. Treasuries: If U.S. stocks remain strong and risk appetite for funds is not weak, then Treasury yields may still be relatively high due to the "teeter-totter" effect.

The inflation in the service sector, represented by U.S. rents, remains high, which is a potential consequence of the "MAGA movement." Investment in technology and high-end manufacturing industries drives growth in R&D investment, and a strong U.S. labor market makes it difficult for U.S. inflation to decline rapidly.

The execution and effects of the Trump 2.0 policy remain unclear. The inflation effects of potential tariffs and immigration policies, combined with the downward pressure on commodity prices driven by increased oil supply, create an unclear "commodity inflation" effect.

We believe that as long as U.S. inflation does not rebound significantly, stubbornly high inflation will not be the main factor in pricing. In this scenario, the main factors will still be the progress of the technology industry and the "stock-bond teeter-totter effect."

U.S. Dollar: Future trends depend on the direction of the interest rate differentials between the U.S. and non-U.S. countries brought about by AI.

In this round of dollar liquidity tide, the dollar continues to flow back to the United States. On the surface, the direct reason for this trend is the relatively strong performance of the U.S. economy, the current attractiveness of U.S. stocks, and the high level of interest rate differentials between the U.S. and non-U.S. countries. However, the deeper reason lies in the asynchronous interest rate cycles between the U.S. and non-U.S. economies, with the U.S. being in a leading position in this round of the AI industry wave. Rapid development in technological innovation and high-end manufacturing, along with potential high yields, have become important driving forces for the dollar's return.

Author of this article: Zhou Junzhi S1440524020001, Sun Yingjie, Source: CSC Research Macro Team, Original title: "U.S. Stocks, U.S. Treasuries, U.S. Dollar, When Will the Turning Point Arrive"

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