Summary:

• Pressures in overseas bond markets continues to mount. Sustained growth in AI-related capex among US corporates has increased these firms' reliance on bond financing. In addition, the continued widening of the US fiscal deficit in recent months has led to a sharp increase in net issuance of US Treasuries over the past two months, adding further upward pressure to global sovereign bond yields.

  
  

• The widening US fiscal deficit mainly reflects tariff refunds and tax reductions for corporations and individuals under the OBBB Act. Markets remain divided over whether the Fed will hike rates in September. Yet in our view, even if the Fed holds rates steady in September, upward pressure on medium- and long-term US Treasury yields will persist.

• Global liquidity flowing into US financial assets continues to exceed the US current account trade deficit. As a result, the US has shifted from a global liquidity provider to a net liquidity absorber. This year, the net amount of global liquidity drawn into the US has hit a new high, contributing to higher global financing costs and interest rates. Among foreign investors' US asset holdings, more capital is flowing into US equities and US corporate bonds, making the upward trend in Treasury yields hard to reverse quickly.

  
  

• Chinese authorities have maintained tight oversight of cross-border capital flows, shifting more decision-making power for outbound investment from the private sector back to the government. At the same time, China has reduced holdings of US financial assets and scaled up investments in key overseas strategic assets and infrastructure projects in partner countries. As a result, China’s trade surpluses no longer flow back directly into US financial assets. Meanwhile, China is fostering steady appreciation of RMB forwards to offset the “loss” for domestic capital barred from overseas financial investments. This reflects Chinese authorities’ efforts to retain more domestic capital and reduce dependence on US financial markets to draw low-cost capital from China and support US domestic AI investment.

• Markets are closely watching the Fed’s September rate decision. In our view, even if the Fed keeps rates unchanged, overseas sovereign bond yields will still face further upward pressure as financing demand rises. We maintain a neutral stance on US equities.

• We believe the downside for A-shares is limited and maintain a moderately bullish view. With stronger policy support for economic stabilization and margin financing balances having fallen to a year-to-date low, we expect A-shares are more likely to rebound in Q4 than to slide further. Previously, we held a constructive view on commodities. However, as oil prices have risen above $100 per barrel, we have become more cautious about increasing commodity exposure at current levels.

Previous Views:

Financing pressures in US equities and remained relatively manageable in Q3, but we expected these pressures to re-emerge in Q4. We therefore maintained a neutral view on US equities. In our view, the earlier low point of A-shares is likely to mark the year’s trough, and we recommend investors rebuild A-share positions. The joint FX market intervention by the US and Japanese central banks should also support base metals and precious metals. Commodities that suffered notable declines in Q3 are expected to see some room to recover.

Views in September:

I. Pressure in the global bond markets may continue to mount.

Yields on government bonds of major developed economies, led by the US, have risen markedly in recent months. Several factors account for this trend. First, as noted in our last monthly report, sustained growth in AI-related capex among US corporates has steadily increased corporate bond financing. In particular, the net issuance of medium- and long-term corporate bonds has hit its highest level in recent years. This has partly increased competition for investor demand across medium- and long-term sovereign bond markets, pushing up government bond yields worldwide. In addition, the continued widening of the US fiscal deficit in recent months has led to a sharp increase in net US Treasury issuance over the past two months, another key driver of rising global sovereign bond yields. As shown in Figure 1, the US cumulative federal budget deficit for FY2026 stood at about $1.25 trillion through May, still lower than the same period last year. However, with a larger deficits in June and July, the US fiscal deficit for the current fiscal year exceeded $1.8 trillion by the end of July, with the monthly deficit reaching $430 billion in July alone.

One major driver of the rapid expansion of the US fiscal deficit over the past two months stems from the ruling by the US Supreme Court that last year’s tariffs imposed by the Trump administration were unlawful. Beginning in May, the US government began to refund the $140 billion in excess tariffs. This has caused tariff revenues to plunge into negative territory over the past two months. Compared with the same period last year, the average monthly tariff revenue gap over the past two months exceeds $40 billion. We estimate that tariff refunds could add more than $160 billion to the FY26 deficit.

In addition, the tax cuts for corporations and individuals introduced under the OBBB Act, rolled out by the Trump administration in the second half of last year, have also weighed on US fiscal revenues this year. In particular, the generous tax incentives for large high-income enterprises on substantial capex and R&D expenses have led to a notable drop in US corporate income tax receipts in FY26 compared with FY25 (Figure 3), adding to the widening fiscal deficit. Against this backdrop, the pace of US Treasury issuance picked up markedly in Q3. Net Treasury issuance exceeded $300 billion in both July and August, with the combined amount over these two months nearly matching the total for the first half of the year. Meanwhile, gross US federal debt surpassed $40 trillion in August. The increase from $30 trillion in January 2022 to more than $40 trillion took about four and a half years.

Nevertheless, we believe the factors contributing to upward pressure on global bond yields remain in place. First, the widening US fiscal deficit has not run its course. The Trump administration has made tax cuts for corporations and individuals permanent, yet it cannot effectively deliver on measures such as substantially raising tariff revenues or slashing medicare spending. Meanwhile, inflationary pressure stemming from rising oil prices prevents the Fed from cutting interest rates anytime soon. This will further amplify pressure on US Treasury interest expenses, keeping the fiscal deficit expanding and boosting the supply of US Treasuries. Furthermore, demand for AI financing from US corporates is unlikely to reverse in the short run. Firms that have already poured trillions of US dollars into AI capex will not abandon these investments halfway.

II. Rising Overseas Bond Yields Highlight New Contradictions in Global Capital Flows.

Besides the sharp rise in US Treasury financing needs and global corporate bonds markets, the broad-based increase in overseas bond yields also highlights emerging imbalances in global capital flows. Before the pandemic, the US current account deficit stood roughly $500 billion per year. Since then, the US current account deficit expanded rapidly to an annual range of $800–900 billion (Figure 4).

Looking at annual data on inflows into US capital markets (Figure 5), before 2020, net international inflows to the US under the capital account stood at roughly $200 billion per year, markedly below the US annual current account trade deficit at the time. On this measure, the US could be viewed as a net supplier of global US dollar liquidity during this period. From 2021 to 2024, however, the US current account trade deficit widened to over $800 billion annually, and net foreign inflows into US financial markets surged to nearly $1 trillion each year. In 2025, the current account trade deficit reached about $1.1 trillion, while net global inflows into US capital markets reached as high as $1.6 trillion.

A closer look at changes in the composition of US assets purchased by global investors shows that since 2024, they have ramped up purchases of US equities and corporate bonds while sharply cutting back on buying US Treasuries (Figure 6). For instance, in the first half of this year, foreign investors made net purchases of US financial assets worth $934.3 billion, including $396.7 billion in US equities and $181.8 billion in US medium- and long-term Treasuries. Purchases of US corporate bonds stood at $216.8 billion, exceeding spending on Treasuries. Meanwhile, the total US current account trade deficit in the first half of this year was merely $358.6 billion, far smaller than the volume of US financial assets bought by foreign investors. This indicates that the pace at which the US absorbs net capital from the rest of the world continues to accelerate. In other words, funding pressures stemming from the widening US fiscal deficit and rising AI-related financing needs may continue to affect global financing conditions as the US.

III. China’s Responses to the US’s Growing Absorption of Global Capital.

The US’s growing absorption of global capital may have important implications for China and draw greater attention from Chinese policymakers. Tightening capital controls and curbing abnormal cross-border capital flows will inevitably be among the policies the Chinese government adopts. As the world’s largest trade surplus nation, strengthening capital account controls on the private sector will shift more investment from the private to the public sector. In terms of official reserve allocation, purchasing US financial assets such as US Treasuries and US equities will clearly not be the primary investment choice for forex reserves. In fact, the Chinese government has been continuously reducing its holdings of US Treasury bonds. Instead, Chinese authorities are more likely to scale up investments in strategic physical assets including gold and mineral resources, as well as infrastructure projects in partner countries such as Belt and Road partner economies. Meanwhile, the government will support Chinese enterprises in exploring new overseas markets. This shift means a smaller share of China's external surpluses may be recycled through official holdings of US Treasuries, even as financing demand for US financial assets keeps expanding. This shift may tighten global financing conditions, particularly as US financing needs remain elevated. Government bond yields have recently risen across several major developed markets, while Chinese government bond yields have moved lower amid weak domestic demand and expectations of further policy support.

Therefore, the challenge facing Chinese authorities is that, as the onshore-offshore interest rate differential continues to widen, capital controls alone may not contain the private sector’s appetite for overseas financial investments over the long run. In practice, maintaining a steady appreciation of the RMB serves as an important tool to curb capital-outflow pressures driven by the China-US interest rate gap. We can treat the yield spread between 1-year US Treasury bonds and 1-year Chinese government bonds as the “opportunity loss” of keeping capital onshore rather than investing in overseas financial assets.

As Figure 7 suggests, if the Fed raises rates and pushes the 1-year US Treasury yield higher, the premium on the 1-year RMB forward may widen further. In other words, investors holding RMB will need a larger appreciation gain to offset the bigger “loss” from the widening China-US yield spread. That means, Fed rate hikes may accelerate RMB appreciation against the US dollar in the period ahead.

This policy response may also be viewed in the context of, the broader US-China competition in advanced technology and supply chains, particularly in AI, as Chinese authorities seek to prevent the US from leveraging its advantages in financial markets to draw low-cost capital from China and accelerate its AI investment. Nevertheless, China’s policy response will, for one thing, push up funding costs in overseas financial markets. For another, RMB appreciation will continue to squeeze profit margins for Chinese exporters. But given that China’s export growth remains resilient at present, we believe there is still room to pursue this policy approach further.

IV. Market strategy

Markets are closely watching whether the Fed will raise rates in September. In our view, even if the Fed leaves rates unchanged, global sovereign bond yields may remain under upward pressure as financing demand rises. We maintain a neutral stance on US equities. Higher yields weigh on equity valuations, yet optimism over AI-driven earnings growth continues to underpin US stock prices. Meeting these earnings expectations, in turn, hinges on continued access to financing for US corporates, especially AI firms.

We believe the downside for A-shares is limited and remain moderately bullish. Weak domestic economic data and margin-account deleveraging in the equity market have been the primary drags on A-share performance recently. With stronger policy support for economic stabilization and margin financing positions at an annual low, we expect A-shares to be more likely to rebound in Q4 than to slide further. Previously, we recommended going long on commodities. However, with as oil prices approaching $100 per barrel, we believe higher commodity prices are beginning to exert greater pressure on global monetary policy and end-user demand. Accordingly, we advise investors not to add new long positions at these levels.