US Interest Rates Won't Fall Easily…Supply and Demand Shifts

In the past, bonds served as an insurance function to diversify risk during stock market downturns, acting as a core element of asset allocation.

Institutional investors, such as central banks, pension funds, and insurance companies, have historically regarded government bonds as a primary source of demand based on their asset allocation strategies.

However, since the pandemic, the correlation coefficient between stocks and bonds has turned positive, indicating that both assets tend to move in the same direction.

This co-movement phenomenon has diluted the insurance value of bonds, leading to changes in traditional asset allocation principles.

Major central banks were key buyers of US Treasury bonds, utilizing their foreign exchange reserves.

However, the growth in foreign exchange reserves of most countries has slowed over the past decade due to factors such as China's export slump and falling commodity prices in Brazil.

With foreign exchange reserves stagnating in major countries, excluding a few like South Korea and Indonesia, the demand base for US Treasury bonds has weakened.

In the past, defined benefit (DB) retirement pensions also functioned as major players in the market, primarily purchasing government bonds under the company's management responsibility.

However, with the recent shift to defined contribution (DC) plans, individuals are now directly managing risky assets such as exchange-traded funds (ETFs), reducing demand for government bonds.

Based on the OECD average, the proportion of DC plans is expected to significantly expand between 2004 and 2025, which is projected to lead to a decrease in demand for long-term government bonds.

This structural change in pension management is an irreversible trend, acting as an upward pressure on government bond yields.

With the demand base for government bonds drying up, interest rates are not expected to fall rapidly in this structural environment.

While there are some movements by individual investors to directly purchase Treasury bond ETFs, it is analyzed that this has limitations in replacing the massive demand from institutional investors in the past.

An analysis suggests that even if inflation decreases, it will be difficult for interest rates to fall significantly and immediately.

Therefore, a portfolio approach utilizing a 5% US Treasury yield remains valid, but there is also a warning that aiming for rapid profits solely by relying on interest rate cuts is risky.

While there is short-term speculative demand in the market, analysis indicates that the previous structural demand, which consistently purchased government bonds, has significantly weakened without our notice.

In addition, the continuous increase in the supply of Treasury bonds due to the US fiscal deficit is burdening the market.

Japanese asset managers have sold off all their French bonds and switched to German government bonds, deepening the interest rate reversal phenomenon. France, which had a more solid fiscal position than Italy, faced political instability and fiscal deficits, leading to foreign holdings exceeding 50% of the total issuance flooding the market. As Japanese asset managers sold all French bonds and moved to German government bonds, the situation has reversed compared to the fiscal crisis of the 2010s, with French interest rates now surpassing Italy's.

More than 50% of French government bonds are held by foreign investors, leading to strong selling pressure.

Indeed, cases of Japanese asset managers selling all their French bonds and switching to German government bonds demonstrate the deepening outflow of foreign capital.

Since 1990, US nominal growth has reached its peak, intensifying upward pressure on interest rates due to growth. Investors have adopted strategies such as reducing bond allocations, perceiving the US as a relatively superior asset, or moving to 'less ugly' assets like German government bonds within Europe. Despite the risks, US Treasury bonds are increasingly seen as a better alternative compared to the global market.

Despite overall risks, US Treasury bonds are perceived as a relatively better alternative compared to the global market.

The US nominal growth rate is at its highest level since 1990, and analysis suggests that the current rise in interest rates also includes a component related to growth.

With strong contention between bond market demand and upward pressure on interest rates, fluctuations within the 5% range are expected. Given the persistent fiscal issues, it is analyzed that interest rates are more likely to maintain their current levels rather than suddenly plummeting.

Conversely, there is also a possibility that interest rates could rise due to fiscal issues, creating a tug-of-war between demand for US Treasury bonds and upward pressure on interest rates.

Unlike the early 2010s during the European fiscal crisis, when Greek interest rates surged, interest rates in relatively safe countries like the US, Germany, and the UK actually fell.

However, currently, global interest rates tend to move in tandem, irrespective of the strong US economy.

Concerns are being raised that increased European bond risks could lead to a synchronized global interest rate hike and impact stock prices.

Pension funds are moving away from cap-based investments that previously limited bond and stock allocations, simplifying their portfolio strategies to risk-weighting approaches such as '75% stocks, 25% bonds'.

Within these changes, the proportion of 'private credit,' which includes stable dividend assets like data centers, is on the rise.

Investments in unlisted artificial intelligence (AI) companies and related infrastructure are emerging as a core component of pension fund portfolios, and even with high interest rates, data centers provide consistent dividends, making them perceived as stable investment targets.

There is a significant disparity between strong and weak stocks in the market. Given that interest rates are unlikely to fall quickly, it is crucial to be more cautious in stock selection.

This indicates a very large disparity between definite stocks and those that are not, in the market.

It is advised to recognize that interest rates are unlikely to fall rapidly and that a more precise stock selection is needed, rather than interpreting the index's all-time high as a general market boom.

Due to current structural factors, it is analyzed that US interest rates are unlikely to fall significantly and rapidly.

Consequently, investors are choosing US Treasury bonds among government bonds or maintaining a preference for the AI sector, which still has high growth potential.

There is a notable concentration of funds seeking reliable returns towards bonds and AI-related stocks.

Even if demand for US Treasury bonds increases, the structure does not allow for a sharp drop in interest rates, so fluctuations above 5% should be accepted as a given.

Interpreting the index's all-time high as a general market boom is a misconception, as there is a significant disparity in returns among stocks within the stock market.

Therefore, selective investment focusing on precise stock selection is advised to sharpen investment ideas.