Investors are currently grappling with the unpredictability of U.Seconomic policies and their implications for the global economyThis uncertainty has led to an unusual increase in U.STreasury yields, pressure on the stock market, and a stronger dollarAnalysts are predicting that a flurry of executive orders may soon be announced, aimed at fulfilling commitments that include stricter immigration control, increased tariffs, domestic tax cuts, and relaxing financial regulationsWhile these policies may spur economic growth in the short term, they also risk elevating inflationConsequently, the Federal Reserve's plans for interest rate cuts may be hamperedAccording to futures prices tracked by the Chicago Mercantile Exchange's FedWatch Tool, financial markets foresee only one rate cut by the Federal Reserve in 2025.

Nobel laureate and liberal economist Paul Krugman recently stated, "If there is any substantial portion of the agenda to be implemented, the Fed is certainly going to have to pause any further rate cuts

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In fact, the Fed may feel the need to raise rates again." This reflects the delicate balancing act the Fed must perform amidst a backdrop of conflicting policiesWhile the administration's tax cuts and deregulation could stimulate economic growth, the imposition of tariffs and aggressive immigration policies could stoke inflation from the supply side, necessitating a longer period of higher interest ratesA persistent environment of high inflation coupled with elevated rates may counteract the upward momentum of the American economy and potentially plunge it into stagflation.

Key to this situation are the immigration and tariff policies; should they be more stringent than anticipated, it may lead to a phenomenon known as stagflation trading, characterized by weakening stocks and bonds alongside a strengthening dollarConversely, if these policies are less intense, or if deregulation and cuts in government spending are more pronounced, a disinflationary trade could ensue, with both stocks and bonds rising but the dollar weakening.

This backdrop is underscored by recent movements in the 10-year U.S

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Treasury yield, which surpassed 4.7%. On Wednesday, it reached 4.73% during intraday trading, marking the highest level since April of the previous year, although it ultimately closed slightly lower at 4.692%. As yields on Treasuries rose, the stock market faced pressure, while the dollar index surgedFor instance, as of January 8, the Dow Jones Industrial Average fell by 5.4% from its historical high of 45073.63 achieved on December 4, whereas the dollar index had increased by 2.5% during the same periodThe robust dollar affected global currencies, with the offshore renminbi briefly touching around 7.37 against the dollar.

Typically, when the Federal Reserve embarks on a cycle of monetary easing, Treasury yields tend to decline in tandem with interest rate cutsHowever, despite the Fed's initiation of this easing cycle in September, the 10-year yields have risen by over 100 basis points, outpacing the cumulative reduction in the federal funds rate of just 100 basis points

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U.STreasury Secretary Janet Yellen noted that stronger-than-expected economic data have spurred a reevaluation of interest rate expectations in the market, resulting in falling bond pricesSince bond prices and yields move inversely, rising yields signify declining prices.

"When we see strong data—indicators of economic performance that exceed expectations—it suggests that the future path of interest rates will be slightly higher than previously forecasted," Yellen remarked in an interview with the U.SConsumer News and Business Channel on WednesdayAdding to the narrative, on Tuesday, the Labor Department reported an unexpected rise of 259,000 in JOLTS job openings in November, surpassing 8 million for the first time in six monthsAdditionally, the ISM Non-Manufacturing Purchasing Managers Index rose to 54.1% in December, an increase of 2 percentage points from the previous month and also outperforming market expectations

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This indicates that demand remains robust; notably, the price index expanded dramatically by 6.2 percentage points to 64.4%, a peak since March 2023, reflecting soaring input costs.

In addition to the economic data acting as a catalyst, analysts believe that the sustained rise in Treasury yields is closely tied to market expectations regarding new U.SpoliciesThe call for broader and more significant increases in tariffs and restricting immigration implicitly points towards inflationary pressuresAt the same time, the push for domestic tax cuts, expansionary fiscal policy, and deregulation supports economic growth, further contributing to inflationary trends.

All signs point to a notable hawkish shift in the messages emanating from the Federal Reserve, reflected in the December monetary policy meetingThis tone was evident not just in the decisions regarding interest rates but also in the projections for future rate paths presented in the "dot plot". Although the Fed did opt for a 25 basis point rate cut in the December meeting, the updated projections for potential rate cuts in 2025 were halved, reflecting cautious optimism

The Fed officials now anticipate two cuts in 2025, totaling 50 basis pointsFed Chair Jerome Powell indicated that "a slower pace of cuts reflects the higher inflation data we've encountered this year, and the expectation that inflation may still be elevated in 2025."

Moreover, minutes released by the Federal Reserve on Thursday revealed considerable concern among officials regarding inflation and the possible ramifications of U.Spolicies"Almost all" officials acknowledged an uptick in the risks of inflationFederal Reserve Board Governor Lisa Cook emphasized at an economic conference in Michigan that, given the resilience of the labor market and persistent inflation, decision-makers should approach further rate cuts with caution.

Looking forward, analysts expect the once-dominant trading patterns may shift more towards stagflation tradingAccording to Zhong Zhengsheng, chief economist at Ping An Securities, most of 2024 will see this trading scenario unfold, with the focus shifting towards smaller-cap stocks and cyclical sectors while Treasury yields and dollar indices continue to rise alongside fluctuations in gold and crude oil prices.

He remarks that a cooling of this trading suggests that investors are increasingly cognizant of the perceived risks surrounding monetary tightening and even stagflation, triggered by the hawkish narrative from the Fed's December meeting and the underlying contradictions of the U.S

policiesHe further elaborates, "Despite policies like tax cuts and deregulation being advantageous for economic growth, tariffs and deportation of immigrants may exacerbate inflation from the supply side, ultimately leading the Fed to maintain elevated interest rates." This continuous inflation and high-interest environment could counteract the forces driving the economy upward, potentially nudging it toward a stagflation scenario.

Similarly, analysts have noted that recent signs suggest a wavering stance on tariff policiesReports indicate discussions about more targeted rather than blanket tariffs for imports, focusing on sectors critical to national securityHowever, these claims were soon refuted through social media as false by the officialRegardless, there has been a notable softening in tariff policiesOn November 25, it was proclaimed on social media that a 25% tariff would apply to imports from Mexico and Canada, with tariffs of 10%-20% on imports from other countries

Furthermore, with respect to immigration policy, on December 8, there was mention of a considerable initiative to deport millions of illegal immigrants, starting with those convicted of crimes, which implies a phased approach to deportation.

Overall, the pressure for re-inflation in the U.Smay prove to be less severe than anticipated by the market, potentially affording the Federal Reserve some leeway for interest rate cutsNotably, tariff-driven inflation mainly influences goods prices, yet the current inflation pressures in the U.Sare largely driven by servicesThis limits the immediate impact of tariffs on inflationAdditionally, the imposition of tariffs seems likely, yet immigration policy is contingent on employment and inflation trends, and tax cuts will require Congressional approvalThus, the policies emerging during this new phase are not wholly comprehensive, suggesting that the associated risks of "re-inflation" may remain manageable for the time being.

"The market currently holds an overly pessimistic outlook regarding the Federal Reserve’s path to reducing interest rates