Current Market Trading Logic: Recession Expectations Dominate, Stagflation Risks Emerge

The trading logic in the current market is mainly dominated by recession expectations, while the risk of stagflation is also gradually becoming apparent.

From the signals in the interest rate market, the 2-year U.S. Treasury yield has quickly fallen, and the spread with short-term financing rates is widening. At the same time, the 10-year yield has dropped below short-term financing rates, reflecting that the market is pricing in expectations of an economic slowdown and the Fed being forced to cut interest rates ahead of time. The inversion of long-term rates further strengthens the recession warning.

There is a certain contradiction in terms of liquidity. Although the consumption of the Treasury Department's account has led to a marginal improvement in dollar liquidity, the market's risk aversion has caused funds to withdraw from high-risk assets and surge into the treasury bond market, creating a contradictory situation of "loose liquidity but shrinking risk appetite."

The Roots of Volatility in Risk Assets: Weak Economic Data and Policy Uncertainty

Recent turmoil in risk assets can be attributed to two main reasons:

First, the economic data is weak. The consumer confidence index has plummeted, and there are signs of cooling in the job market. Coupled with potential tariff threats, the market's concerns about a "hard landing" for the economy are intensifying.

Secondly, there is the uncertainty of policies. AI narratives face challenges, and the market has doubts about the commercial viability of AI, leading to a sell-off of tech stocks, especially in the computing power sector.

The cryptocurrency market is also experiencing a chain reaction. Changes in the structure of the futures market have weakened the attractiveness of arbitrage, combined with ETF capital outflow, leading to a synchronized decline of Bitcoin and U.S. stocks, with a noticeable rise in market panic.

Key Battle Points Next Week: Non-Farm Data Will Set the Tone for the Strength of "Recession Trades"

The key battleground in the market next week will be the non-farm payroll data, which will determine the strength of the "recession trade."

If the non-farm payrolls in February continue to exceed expectations, or if the manufacturing PMI continues to decline, it will further strengthen recession pricing, pushing down U.S. Treasury yields and putting pressure on risk assets. Conversely, if the data exceeds expectations, it may temporarily restore the market's expectations for a "soft landing."

Attention should be paid to the details of potential tariff policies and the statements of Federal Reserve officials regarding the interest rate reduction path, as these may trigger market fluctuations.

In the current environment, the investment strategy is advised to focus on defense while waiting for opportunities to counterattack. The short-term selling pressure in the crypto industry comes from the withdrawal of leveraged funds, but in the long term, regulatory easing and technological innovation continue to support its growth potential.

Stagflation or recession, what is the market trading?

Macroeconomic Review of This Week

1. Liquidity and interest rate changes

The marginal liquidity has improved, mainly due to the consumption of the Treasury account. The dollar-based liquidity has increased by $39 billion compared to last week, but it is still lower than the same period last year. The Treasury account has rapidly decreased from $800 billion in mid-February to currently over $530 billion.

The interest rate market has begun to price in interest rate cuts, and long-term government bond yields reflect expectations of economic slowdown. The yield on 2-year government bonds has shown a significant divergence from short-term financing rates, and the yield on 10-year government bonds is also below short-term financing rates. This reflects the following points:

• Against the backdrop of deteriorating economic data, the market's expectations for a rate cut by the Federal Reserve this year have risen. Short-term financing costs being higher than long-term rates usually indicates that the tightening cycle is nearing its end.

• The short-term financing interest rate has not been priced down, indicating that the Federal Reserve is still managing short-term liquidity to prevent the market from overheating.

• The downward slope of government bond yields is large, reflecting strong risk aversion in the market, with funds quickly flowing into government bonds.

Overall, although the Federal Reserve is still maintaining a tight stance on short-term interest rates, the results in the treasury market indicate that, under the influence of multiple factors, the market is pricing in "an economic slowdown forcing the Fed to cut interest rates."

2. Risk Market Review

The US stock market has experienced significant volatility this week. Following last week's weak data, selling pressure continued, and the VIX index remained above 19. Market focus has shifted from inflation to economic data, particularly with the sharp decline in the consumer confidence index, which has reignited recession fears. It wasn't until Friday's PCE data was released that market sentiment eased, leading to a rebound in US stocks.

In addition to economic data, AI narratives also face challenges. Following Nvidia's earnings report, the controversy over "Scaling Law failure" has resurfaced, coupled with OpenAI's new technology raising market doubts about the commercialization of AI, leading to a sell-off in tech stocks, particularly in the computing power sector. This reflects that the market is adjusting and repricing its expectations for the AI mainline.

The cryptocurrency market is shrouded in gloom this week. Against the backdrop of declining overall risk appetite, funds are flowing into government bonds for safety, and the crypto industry is experiencing a significant pullback, with strong market panic.

Despite a marginal improvement in dollar liquidity, high-risk assets have not benefited as the market prices in interest rate cuts due to concerns over economic slowdown. Funds tend to withdraw from high-risk assets and shift towards the government bond market.

The price difference between the Bitcoin futures market and the spot price has narrowed, even resulting in futures trading at a discount. This has weakened the attractiveness of basis arbitrage, leading to hedge funds withdrawing, outflows from Bitcoin ETFs, and escalating market concerns and sell-offs. It wasn't until Friday's PCE data eased risk appetite that the market rebounded.

Outlook for Next Week

The market is at a turning point of expected sharp adjustments, with complex gaming factors increasing trading difficulty. It is necessary to closely monitor the latest data and adjust expectations in a timely manner.

Key macroeconomic data next week includes ISM Manufacturing PMI, ADP Employment Change, Non-Farm Payrolls, etc.

The latest GDP forecast from the Atlanta Federal Reserve indicates that the GDP for the first quarter of 2025 may be -1.5%. While part of the reason is due to seasonal factors, it also reflects an increased risk of economic slowdown under potential tariff policy threats. The market is facing a dual adjustment of "reinforced recession expectations" and "policy impacts," and asset prices are likely to remain highly volatile.

Non-farm payroll data will be key in determining whether the market further strengthens the "recession trade". Based on this, we recommend:

• Due to risk considerations, it is not advisable to blindly chase highs. If risk appetite stabilizes, a corrective rebound may occur, but volatility risks should still be taken into account.

• Increase investment diversification, allocate defensive assets and quantitative strategy products, and balance risk and return.

• Closely monitor changes in market expectations brought about by economic data, interest rates, liquidity, and policies.

Although the short-term decline has impacted market sentiment, in the long run, regulatory easing and technological innovation still support the growth potential of the cryptocurrency industry. The short-term capital outflow is primarily due to risk management needs and does not indicate a pessimistic outlook for the industry. We remain confident in the long-term development of Bitcoin and the cryptocurrency sector.