Summary of Key Points
After the U.S. non-farm payroll data for May far exceeded expectations, the stock market (especially the Nasdaq) tumbled by more than 4%, and the yield on two-year U.S. Treasury bonds soared. On the surface, it seems the market is worried about the Federal Reserve's interest rate hikes, but the underlying reason is more complex: The U.S. government is burdened with $39 trillion in debt, and rising inflation will lead to a massive increase in interest payments (an additional $390 billion per 1% increase in rates). To avoid a "debt cliff," the government must control interest rates. However, the two methods to do this—opening the Strait of Hormuz to lower oil prices or curbing private debt growth—will both drain liquidity from the stock market, causing it to decline.
Why Are Good Non-Farm Data Actually Bad News?
Non-farm data exceeding expectations (172,000 jobs vs. expected 85,000) indicates that the U.S. economy is still strong, and inflation may be difficult to curb. Higher inflation means higher nominal interest rates, and with the government's $39 trillion in debt, every 1% increase in rates results in an additional annual payment of $390 billion, which the government cannot afford. As soon as the data was released, the market realized that the government would have to take action to prevent further rate increases, leading to a drop in the stock market. Consequently, investors quickly sold their stocks, causing the Nasdaq to plummet by more than 4%.
The U.S. Government's Biggest Fear Is Not Inflation, but the "Debt Cliff"
Many believe the government is concerned about inflation affecting people's lives, but for it, debt is the real threat. With $39 trillion in debt, even a slight increase in rates would lead to explosive interest payments. For example, if the yield on two-year Treasury bonds rises to 4.14% and continues to climb, the government might become unable to afford the interest payments (this is what a "debt cliff" entails). Therefore, the government's ultimate concern is not public complaints about high prices but avoiding the debt cliff; once it is crossed, its credit will be ruined, and everything will go out of control.
Two Methods to Control Interest Rates Both Harm the Stock Market
There are two main ways to control interest rates (nominal rates), both of which are negative for the stock market:
1. Lowering Real Interest Rates: Opening the Strait of Hormuz
Real interest rates are the true interest rate after accounting for inflation, and to lower them, oil prices must fall (since oil is a major source of inflation). The Strait of Hormuz is a critical oil transportation route; its opening would reduce oil prices. However, this would also lead to a return of funds that were previously invested in the stock market (due to production halts caused by the blockade) back into the real economy (for oil purchases), reducing market liquidity and causing the stock market to decline.
2. Curbing Private Debt Growth: Restricting AI Investments
Private debt in the U.S. is growing rapidly, especially in AI-related sectors (such as tech companies borrowing for AI development). These investments are driving up overall debt growth and interest rates. To curb private debt, restrictions on high-growth investments like AI would be necessary, which would directly impact the Nasdaq, as it contains many AI companies.
The Stock Market and the Real Economy Compete for Funds
The stock market and the real economy compete for funds; money can either be invested in the real economy (such as starting factories or buying raw materials) or in the stock market. For example, during the pandemic in China, when factories were shut down, investors turned to the stock market, causing it to rise. Once production resumed, funds flowed back into the real economy, leading to a market decline. Currently, with the stock market at high levels, much of the capital has moved from the real economy to the stock market. If the government takes action (such as opening the Strait of Hormuz to revive the real economy), these funds will return to the real sector, causing the stock market to fall.
What Might Happen in the Future?
Based on this analysis, the following changes are likely:
- The Strait of Hormuz may be opened to lower oil prices and real interest rates.
- Private debt growth will slow down as AI investments are restricted.
- U.S. Treasury bond yields will eventually decline as the government manages its debt pressure.
- The Federal Reserve may start reducing its balance sheet and lowering interest rates, but only after private debt has decreased.
- The stock market is likely to experience another downturn as liquidity is drained.
The IPO of SpaceX could be a sign of the peak of private debt growth; afterward, private capital will need to support government debt, ending the good times for the stock market.
Conclusion
The recent sharp drop in the U.S. stock market is not simply due to expectations of interest rate hikes but is an inevitable outcome of the government's debt pressures. To avoid falling into a debt trap, the government must sacrifice stock market liquidity, which is why the Nasdaq plummeted. For individual investors, it is important to understand that the performance of the U.S. stock market is ultimately tied to the government's debt situation.
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