What the Bond Market Is Telling Us
One of the big topics on Wall Street over the past few weeks has been interest rates. I’m not talking about the Fed funds rate, which is the one mentioned after Fed meetings and where the Fed actually has some control. I’m talking about long-term rates.
These rates are set by the market. The market will take hints from the Fed, but if the Fed, White House, or Treasury Secretary Scott Bessent want to lower long-term rates, they have fewer options to influence the market. It’s possible to impact the market with something like “quantitative easing,” which is essentially printing money to buy bonds, but you'd better do it at a massive scale with $40 trillion in debt outstanding!
That hasn’t happened, and the market is now demanding a higher return (yield) on 30-year U.S. treasury bonds than at any point in the last 20 years. You have to go back to 2002 to find rates consistently this high.
The 10-year is a benchmark for assets like mortgages and bonds, and it’s trading at a level not seen since 2007, outside of the small blips you see below.
What is the bond market saying?
Investors are saying they need a better return in order to hold assets that are viewed as “risk-free.”
This could be because inflation expectations are going up and investors need a return on top of expected inflation, known as a “real rate of return”.
With U.S. debt climbing over $40 trillion, investors may also think their odds of getting paid back as expected are going down. Higher debt leads to higher rates, which leads to undesirable outcomes when paying back bonds. The government could be forced to cut spending, raise taxes, or print money in order to pay back debt. Those factors may all impact GDP growth and inflation negatively.
How does this affect the stock market?
The bond market is 10x the size of the stock market. And the bond market thinks about risk, while equity investors usually think about upside.
When bond investors get nervous, it usually says something about the future of the market.
Eventually, bonds also impact stocks in a more direct way.
In theory, a company needs to earn a higher rate or return when rates go up, so its discounted cash flows become less valuable. This is the equity risk premium in the Efficient Market Hypothesis. In theory, rising rates should lead to falling stocks, all else equal.
In a much more real sense, borrowing rates on debt rise when interest rates rise. And bond investors often flee to safer investments.
This will impact the AI buildout most acutely because it’s now being funded by debt. If rates go up, it’ll become harder to build data centers profitably.
$CoreWeave, Inc.(CRWV)$ ( ▼ 1.82% ) has seen its rates jump this year.
$Oracle(ORCL)$ ( ▼ 2.75% ) rates have been climbing steadily, too.
We’re seeing this dynamic across the market, and last week it seemed to have reached the point where the White House did everything it could to convince the market that lower rates make sense. But it didn’t work, and one could argue that rates didn’t respond positively.
The market is saying something, and if rates keep going up, it’ll have a cascading effect on the market.
Be careful with companies relying on debt to fund growth. That’s an unstable place to build a business right now.
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