The Baycent buyback made it difficult to weigh the pressure on long-term bonds, and US bond yields became the biggest test for US stocks

The Zhitong Finance App learned that if professional investors really worry that rising global bond yields will derail the stock market bull market, then judging from the actual allocation of funds they manage, there is almost no such concern. According to the Bank of America's latest survey, stocks currently account for 56% of global fund managers' portfolios, the highest level since November 2021. Although the same survey showed that “disorderly rise in bond yields” is considered the second biggest risk threatening the stock market after concerns about the AI bubble, investors remain bullish on stocks.

Bullish sentiment is high in the US stock market

Although all Wall Street strategists are watching the rise in US bond yields and have some concerns about this, most of them have come to the conclusion that the current increase in yield is not enough to disrupt the bullish logic of the stock market. After all, history shows that sudden spikes in yield aren't always “poison” for the stock market.

JC O'Hara, chief technical strategist at Roth Capital Partners LLC, said that despite rising yields, the stock market is still near an all-time high, “we should be bullish now, or at least seize the opportunity.” Risk appetite is improving, he said, mainly due to “stronger profit expectations, better economic prospects, and reduced market attention to the situation in the Middle East.” He also pointed out that when risk appetite improves, the S&P 500 index's forward returns tend to be strong.

For those worried about rising US bond yields, there were some signs of relief on Wednesday. At a time when long-term US bond yields have recently climbed to a multi-year high, the US Treasury Department unexpectedly announced on Wednesday that it will step up its repurchases of long-term US bonds. The US Treasury Department said it will “at least double the scale of liquidity support repurchase operations” for bonds between 10 and 30 years. US Treasury Secretary Bezent launched a bond repurchase program last year and sees it as part of the Treasury's “complete set of tools that can be introduced when necessary” to deal with disruptions in the US bond market. After the news was announced, US bond yields fell across the board for various maturities.

However, at present, US Treasury bonds have taken back all of the gains made after the US Treasury announced support — on Thursday, the yield on 30-year US Treasury bonds rose sharply by 6 basis points to 5.26%, returning back to the level before the US Treasury announced an increase in long-term US bond repurchases on Wednesday; 10-year US bond yields have also risen by a similar margin. This indicates that investors believe that the US Treasury's measures may only have a short-term effect in curbing borrowing costs.

Tyler Richey, editor-in-chief of the Sevens Report Technicals newsletter, said in an interview that the rise in US bond yields is the “elephant in the room” threatening the stock market. Matt Maley, chief market strategist at Miller Tabak + Co., said: “Bond yields began to rise, but the stock market turned a blind eye to it — until it stopped ignoring it.”

The US bond yield is the benchmark for global borrowing costs. Its upward trend will be transmitted step by step along the “treasury bond - market interest rate - real economy” chain, and at the same time trigger repricing within the capital market. The essence of stock valuation is to use interest rates to convert future profits to today. The rise in long-term interest rates reduces valuations, and high-valuation growth stocks of US stocks bear the brunt. In the past year, the US stock market hit a record high, but since then it has been difficult to maintain near record highs. Continued high US bond yields are one of the important reasons.

But for other stock market analysts, what is really worth paying attention to is the US Treasury yield curve — that is, the difference between short-term and long-term US Treasury yields. Currently, 10-year US Treasury yields are about 49 basis points higher than 2-year yields.

Ed Clissold, chief US strategist at Ned Davis Research, wrote in a report to clients on Tuesday that the stock market is currently at the “sweet spot” of the yield curve. He described this “mildly upward sloping yield curve” as a favorable environment. Under such circumstances, the 10-year yield can be up to 1.5 percentage points higher than the 2-year yield, and this environment can often bring about the biggest and most stable increase in the S&P 500 index. According to NDR's analysis of data since 1976, the average annual return of the S&P 500 index is about 11% within this yield curve range.

Of course, even current stock market bulls acknowledge that if US bond yields continue to rise, they may eventually reach a critical point where pressure on the stock market begins. Liz Ann Sonders, chief investment strategist at the Schwab Center for Financial Research, said, “I think the current level is acceptable, but if the 10-year US Treasury yield gets closer to 5%, it may really make the market uneasy. This is similar to what happened in 2023.” In 2023, against the backdrop of a sharp rise in 10-year US Treasury yields, which briefly hit 5%, the S&P 500 index fell 10% from the end of July to the end of October of that year.

Agencies warn: US Treasury increases long-term bond repurchases, making the yield curve steeper

Although the measures announced by the US Treasury Department on Wednesday provided a resurgence to the US bond market, the recent rise in US bond yields on Thursday highlighted investors' doubts about the actual effects of the measures, and also echoed warnings from some market institutions that US bond yields may rise again.

According to reports, J.P. Morgan strategists warned that the market may think that the unexpected measures taken by the US Treasury to curb long-term financing costs lack credibility, which may push up term premiums and returns over time. J.P. Morgan strategists, including Jay Barry, wrote in a report, “If there is no real fiscal consolidation, we are concerned that the market will see this action as lacking credibility,” and “if the Treasury becomes more speculative in its debt management methods and deviates further from its 'routine and predictable' principles, this could lead to higher term premiums and yields over time.”

J.P. Morgan also bluntly stated that the US Treasury Department's expansion of repurchases “treats the symptoms rather than the root causes.” The strategist pointed out that this operation essentially only deals with the “symptoms” of rising long-term yields, and does not touch on the fundamental problem — currently the US economy is close to full employment, the fiscal deficit still accounts for about 6% of GDP, and the continued high demand for financing is the core reason why long-term interest rates are under pressure. The bank anticipates that the US financing gap will exceed 3.5 trillion US dollars in the next few fiscal years. Unless fiscal consolidation is substantially promoted, the impact of this repurchase adjustment on long-term interest rates is likely only temporary.

Asset management company Aegon Asset Management is firmly betting that the gap between US short-term and long-term US bond yields will continue to widen. According to James Lynch, the company's portfolio manager, expanding the scale of long-term US bond repurchases “doesn't make much sense” and will not change his view that the yield curve in the US and Europe will continue to steep. Lynch said, “Fiscal issues — huge deficits, the influx of large-scale corporate debt into the market, the inflation rate is still above target levels, and the Federal Reserve's lack of clear communication are all injecting an additional premium into the market. I don't think these factors will go away anytime soon.”

Barclays, on the other hand, believes that although the actual market impact of the US Treasury's latest measures is limited, the significance of the policy signal cannot be ignored — investors clearly know that if long-term yields continue to rise, the US Treasury is willing to adjust the issuance structure. In the future, the US Treasury could further increase the scale of repurchases or clearly reduce the issuance of long-term treasury bonds at the November financing conference. However, citing Japan's experience, the bank said that reducing the supply of long-term bonds can only buy time — after Japan cut the issuance of ultra-long-term treasury bonds in 2025, the 40-year yield once fell by about 50 basis points, then hit a new high again — to actually solve the problem, and eventually it still needs to return to fiscal consolidation.

Furthermore, economists and bond traders believe that if the US Treasury continues to reduce long-term interest rates by adjusting the debt structure, it may stimulate economic activity and increase inflationary stickiness, and at the same time make US government debt financing costs more vulnerable to changes in short-term interest rates. Furthermore, this could put more pressure on the Federal Reserve to maintain its policy independence.

Joseph Brusuelas, chief economist at RSM US, said that the policy is gradually moving in a direction that may require the central bank to support fiscal goals. He believes that the intervention of the Ministry of Finance may distort the market and cause the Federal Reserve under Walsh to face a more difficult policy environment. Wil Sith, senior bond portfolio manager at Wilmington Trust, said that if inflation remains constant or continues to rise, the easing effect of the Treasury depressing long-term yields may force the Federal Reserve to raise interest rates more aggressively.

More importantly, the US bond market, which continues to be under pressure in the near future, will also face another huge wave of debt financing. The US investment-grade corporate bond market usually peaks in issuance after Labor Day. As the financing needs of hyperscale cloud computing companies increase, the scale of corporate bond issuance in September may reach 200 billion US dollars, or have a new round of impact on the already pressured US debt market. As some market participants have warned, US bond yields may eventually rise to a level that cannot be ignored, and at that time, this “elephant in the room” may overthrow the stock market bulls that are still optimistic.