Musha Research Commentary

24 April 2024

S\Strategy
Bulletin (No. 352)

U.S. Rate Cut Delayed, Fed to Curb Resk Taking“Good news is bad news bad news is good news” is a simple statement
about the current U.S. economic situation. The robust performance, which
has not slowed down, is causing expectations of an interest rate cut to fadeaway, which is causing stocks to fall.
Why no slowdown? There are three factors that are accelerating theeconomy. The first is the vigorous value creation by companies due to thenew industrial revolution, the second is fiscal expansion, and the third is
the asset effect of rising stock prices. The Fed will be forced to delay
interest rate cuts. We should assume that its goal is to adjust asset prices
by curbing the appetite for risk-taking. The Fed may be forced to delay rate
cuts. U.S. equities, which surged at the beginning of the year, are likely toexperience a period of adjustment.

(1) Business confidence is not in the doldrums
The U.S. economy is at full employment, inflation is subsiding, and the possibility ofa soft landing is increasing. Employment is strong, but so far wage growth has not
accelerated: the March employment report showed that nonfarm payrolls rose by
303,000 month-over-month, well above market expectations (+200,000).
Employment increased in all industries. Average hourly earnings rose 4.1% y/y, downfrom 4.3% in February. Increased immigration and an improved labor participation
rate have also contributed to the increase in supply.
However, the best-case scenario so far of a resilient economy may turn into a risk
scenario in the future. If this pace of growth continues, prices are likely to accelerate
eventually. The rosy scenario also creates the seeds for a bubble: 2.5% GDP in 2023
followed by a strong 2.7% in 1Q2024, according to GDP Now by the Atlanta Fed.
District Fed presidents, one after another, have begun to stress that there is no rush
to cut interest rates, referring to high inflation and favorable labor supply and demand.
In fact, the CPI rose 3.5% y/y in March, accelerating from 3.2% in February andbeating market expectations of 3.4%. While higher gasoline and housing costs werethe main reasons for the increase, the rate of increase in core service prices, which
the Fed is concerned about, has increased as wages remain lower, reinforcing
expectations of a rate cut delay. The market has been increasingly speculating that
the Fed will hold off on cutting interest rates until September.

(2) Increasingly speculative financial markets
Along with the sharp rise in U.S. equities at the beginning of the year, the U.S.
financial markets have become increasingly speculative. The price of gold surged
14% since the beginning of the year, reaching an all-time high. The gold price surge
has been cited as follows: U.S. price indexes have exceeded market expectations,renewed fears of inflation, central banks in emerging countries such as China, Russia,and Turkey are buying gold, and investors are hedging their bets against a possible
stock market bubble burst. Some believe that “Chinese investors, lacking effective
options, are buying gold” due to the slump in stock prices and deterioration in thereal estate market.

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Bitcoin, which last year hovered between $32,000 and less than $40,000, began to soar after the new year,
doubling in six months to $70,000 by the end of March, breaking the previous peak reached in November
2021. The sharp rise in the prices of gold and bitcoin, assets that generate no cash at all, can be taken as asignal that the market is becoming speculative.
In addition, investment funds are plentiful, and households' abundant savings are flowing into U.S.
Treasuries through MMFs.

Figure1: Gold price at historical high2500
2000
1500
1000
500090 92 94 96 98 00 02 04 06 08 10 12 14 16 18 20 22 24
Source:Bloomberg Musha Research

Figure2: Surging bit coin price
80000
70000
60000
50000
40000
30000
20000
10000
0
17/1

18/1

19/1

20/1

21/1

22/1

23/1

24/1

Source: Bloomberg Musha Research

Expectations of three rate cuts this year, which were announced by the Fed at the January FOMC meeting,have been revised down significantly in the market. The market now expects one rate cut, and the dollar isstrengthening in parallel.
Good news is bad news, bad news is good news,” and the Fed is pondering how to slow down the U.S.
economy, which is likely to overheat and lead to inflation and asset bubbles if the economy continues at thisrate. There are three factors that are accelerating the economy. The first is the vigorous value creation bycompanies due to the new industrial revolution, the second is fiscal expansion, and the third is the asset
effect of rising stock prices. Of these factors, the economic accelerators from the new industrial revolution
and fiscal expansion will remain unchanged for the time being.
The Fed is likely to be forced to delay interest rate cuts, but its aim may be to adjust the appetite for risktaking by restraining stock prices and other asset prices. U.S. stocks, which surged at the beginning of theyear, are likely to face a period of adjustment.

(3) Equity capitalism, a circumstance that will force a delay in interest rate hikes
The reason why asset prices such as stocks are essential for the Fed's control of aggregate demand is thatthe current U.S. economic cycle is centered on the stock market. In other words, it is stock capitalism. Chart
5 shows the evolution of credit creation (credit outstanding/GDP) in the U.S. over the past 70 years. The eraof private-sector debt driven credit expansion that lasted until the GFC of 2008 is over, government debt
driven credit is limited, and the market capitalization of stocks has expanded from 69% to 240% of GDP
over the past 14 years, which has led to the creation of demand driven by stocks.
This increase in equity credit (= higher stock prices) is justified by the entrenched money flow, where almost
80% of corporate profits are returned to the stock market (see Figure 6). Since there are no borrowers
beyond the banks, the former monetary adjustment by the Central Bank, which controlled aggregate demandby controlling bank lending, has lost its power. Instead, asset prices have come to affect aggregate demand,and the Fed introduced QE as a means to achieve this. In other words, this is the era of equity capitalism.
As stocks have come to occupy a central position in the financial markets, a significant drop in stock prices
causes far more damage to the economy than in the past. The Fed needs to focus on avoiding bubbles andmaintaining appropriate stock prices.

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Figure 3: Credit creation shifted from debt to equity
300
250

in the U.S.

(%)
民間債務/GDP
政府債務/GDP

Equity Market Cap./GDP
Government Debt/GDP

200
150
100
500Private Debt/GDP
55 56 58 60 62 63 65 67 69 70 72 74 76 77 79 81 83 84 86 88 90 91 93 95 97 98 00 02 04 05 07 09 11 12 14 16 18 19 21 231960

1970

1980

1990

2000

2010

2020

Sourse:ERB,Bloomberg,Musha Research

Figure 4:Huge Corporate pay out supporting creation of wealth of U.S. House hold

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As seen in Chart 7, even if stock price is not in a bubble right now when compared to interest rates (as seenin the FED model), it is no longer undervalued at all. For the past 20 years, the gap between interest rates
and stock returns has been so large that stocks were significantly undervalued, but that era is over. While
the actual April 12 S&P 500 index was 5123 points the fair value calculated by the Fed model was 5352, so
the two were identical.
If the Fed's ability to control inflation becomes increasingly questionable in the future, or if long-term interest
rates soar due to concerns over the U.S. budget deficit, stock prices are approaching the danger zone ofbeing immediately judged to be in a bubble.
Figure 5: Fair Value Model for U.S. Equity
30000

25000

Fed model
Earnings yield on 12M forward projected EPS=Yield of 10year TN
Bloomberg 12M forw proj. EPS＝$224.0

20000

Theoretical price by Fed model
5352

15000
10000
5000

S&P 500
51530(%)

S&P500 earnings yield
5.4

US 10-yr TN yield
3.4

86 8890 92 94 96

98 00

02 04 06 08

10 1214 16

18 20

10.5
9.58.57.5
6.5
5.5
4.5
3.5
2.5
1.5
0.5

22 24

Note: Data as of Apr. 12, 2024
Source: Bloomberg, Musha Research(4) Steady Fiscal Deficit and High-Pressure Economic Policy Management
It is necessary to take a glance at one more factor causing overheated demand in the U.S.: public finances.
Chart 8 shows the evolution of the unemployment rate and the budget deficit (as a percentage of GDP) in
the postwar period, but it should be noted that since the Corona pandemic, there is no longer any correlation
between the two. In the past, the two were perfectly linked, as budget deficits were rolled out as a demand
creation tool when unemployment rose. However, there is no sign that the budget deficit is decreasing, eventhough full employment has been in place since 2021. The Congressional Budget Office (CBO) projects thatthe budget deficit, at 5-6% of GDP, will remain entrenched at the highest level of any major country through2034.
Big government is likely to take hold, with increased spending for the elderly such as Medicare, industry
support such as the Chips Act and IRAs, and GX/DX measures.
The new industrial revolution will lead to higher productivity and increased supply capacity. Thus, relative
demand shortages are expected, and creative fiscal policies are required as a response. The recent
expansion of the U.S. budget deficit confirms this historical change in the role of fiscal policy. The highpressure economic environment advocated by Treasury Secretary Janet Yellen will continue, but this will be

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24April 2024

accompanied by risks such as higher interest payments due to higher interest rates. In addition, witheconomic fundamentals in excess of demand, there is a risk that the economy could easily slip into an
inflationary or bubble economy. Since we may have entered a situation where policy management requires
caution, risk-taking in the U.S. financial markets also need to be careful.

Figure 6: Unemployment rate and Fiscal Deficit/GDP of the U.S.
16161414

1212

Unemproyment rate (l)1010886462
402

Fiscal defisit /GDP(r)-20-449 52 55 58 61 64 67 70 73 76 79 82 85 88 91 94 97 00 03 06 09 12 15 18 21 24 27 30

Sourse:Bloomberg、CBO,musha Research

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