Did the US stock market and US corporate bonds exceed their "breaking point" this time? They couldn't escape the "interest rate shock".

The surge in US bond yields continues to be driven by factors such as expectations of Fed tightening and increased supply of US bonds. Since the end of July, the yield on 10-year US Treasury bonds has risen by more than 100 basis points, and this week it has surged by 30 basis points, reaching 5%, the highest level since July 2007 and approaching the highest level in 20 years.

As the "anchor of global asset prices," the 10-year US Treasury bond reaching new highs has significantly suppressed global risk assets. At the same time, higher US bond yields and premiums will also increase the cost of credit for businesses and individuals.

While long-term bond yields in the US are soaring, short-term bond yields have risen relatively less, resulting in a "steep bear" yield curve. This indicates that the market's pricing of long-term economic growth has been problematic (concerns about the slowdown in growth and recession), putting pressure on risk assets.

According to the latest market intelligence data from S&P Global, global stock markets have recently hit their lowest levels since April, with the S&P 500 index falling about 8% from its peak in July. Among them, industries such as utilities and real estate that rely on high dividend stocks have been hit the hardest, and regional bank stocks in the US have also been affected.

In the corporate bond market, the recent surge in US bond yields has widened credit spreads again, increasing the financing costs for potential borrowers. This will likely limit corporate bond issuance in October, and the pressure may continue into November.

The commodity market has also experienced severe volatility due to the surge in US bond yields. The surge in US bond yields has raised concerns about the outlook for the US economy, leading to an increase in risk aversion. Intraday, New York gold futures broke through $2,000 per ounce.

The surge in US bond yields has also accelerated the demand for the US dollar. Since mid-July, when US bond yields started to rise rapidly, the US dollar has risen by about 7% against the average of the G10 currencies. The US dollar index, which measures the strength of the US dollar against six major currencies, is approaching a 10-month high.

Nomura Securities' chief economist, Gu Chaoming, pointed out that the surging US 10-year yield is approaching a key point of significant volatility in risk asset prices.

Rapid rise in long-term interest rates pushes the yield curve to steepen

While long-term US bond yields are soaring, short-term bond yields have risen relatively less. The yield on 2-year US Treasury bonds, which is more sensitive to monetary policy, has only risen by 2 basis points. This has led to an important recession warning indicator - the yield spread between 2-year and 10-year US bonds is about -16 basis points, narrowing for five consecutive days, and the yield curve is steepening, resulting in a so-called "steep bear" yield curve (both long and short-term interest rates are rising, but long-term rates are rising faster).The spread between 2-year and 30-year US Treasury yields is about -4 basis points, and the yield curve is at its steepest level since August last year.

Historically, the yield curve of 3-month and 30-year US Treasury bonds tends to steepen before the onset of an economic recession, leading the recession by about five months. The current degree of inversion in the US yield curve has eased, which in a way indicates that the Federal Reserve's efforts to suppress inflation have been ineffective, and it may maintain higher interest rates for a longer period of time, increasing the risk of future economic recession.

Analysts at CICC believe that in general, the bearish steepening of the yield curve occurs more often in the early stages of interest rate hikes (such as March to May 2022), but the current bearish steepness of the yield curve indicates that the market has mispriced long-term economic growth (concerns about the slowdown in growth and recession).

At the same time, the rise in long-term interest rates will in turn suppress long-term growth by tightening financial conditions. The recent rapid rise in Goldman Sachs' financial conditions index has reached a new high since 2022. Unless there is a recurrence of problems similar to the risk exposure of small and medium-sized banks at the beginning of the year, which leads to the re-injection of liquidity by monetary and fiscal policies, the pressure from rapidly tightening financial conditions may gradually manifest on growth:

At that time, with the increase in growth pressure or the occurrence of risk events, it may push the curve down again ("bull flattening", that is, both long and short-term interest rates decline, but long-term decline faster), until the Federal Reserve lowers short-term interest rates again through loose monetary policy, moving towards "bull steepening".

Pressure on US stocks

In several articles, Wall Street News has analyzed that due to the surge in yields, the real estate and other interest rate-sensitive industries have already reacted to the rise in rates, but risk assets such as the stock market have not fully priced in the surge in US Treasury yields. Therefore, if US Treasury yields reach this critical level, it may lead to greater volatility in risk assets.

On Friday, concerns about the decline in the value of US Treasuries held by regional banks led to selling pressure on regional bank stocks in the S&P 500. The SPDR S&P Regional Banking ETF (KRE) fell 4.0%, Westpac Banking Corporation fell 4.6%, and Alliance Western Bank plummeted 8.4%.

In addition, the stock prices of technology and growth companies have also been affected, as the attractiveness of their future expected profits is discounted compared to the higher US Treasury yields. Leading technology stocks have all declined.CIBC's Chief Investment Officer of Private Wealth Management, David Donabedian, stated that the reasons for stock market bulls to increase their positions are becoming fewer, while the reasons to sell are increasing. The market is closely watching the bond market, which is not a good sign:

Despite relatively good progress in inflation, rising yields remain the main reason for the stock market's weakness.

Cooling Down of Corporate Bond Issuance

As US Treasury yields rise and the stock market falls, there are signs of a slowdown in the issuance of US corporate bonds.

The recent surge in US Treasury yields has widened credit spreads again, increasing the financing costs for potential borrowers. The pressure on junk bonds is particularly significant, with yields reaching the highest level in a year.

According to media reports, the average yield of an index measuring global high-yield bonds recently rose to 9.26%, the highest level since November last year, almost double that of early 2022:

Liquified natural gas provider, Venture Global LNG Inc., faced setbacks in its corporate bond issuance last Thursday and had to issue $4 billion in corporate bonds after paying more fees than initially expected.

Even in the asset-backed securities market (which is usually considered a relatively low-risk market, with bonds backed by assets and relatively short maturities), the issuance of corporate bonds has not been smooth. Mexican fast-food chain Qdoba Restaurant Corp. had to reduce its planned issuance size from $325 million to $305 million.

Data shows that new junk bond issuances are almost drying up, with the US junk bond market experiencing its first "zero" issuance week since the week of August 18. In September, the issuance of US junk bonds exceeded $23 billion, making it the busiest month since January 2022.

Previously, Barclays Bank had preliminary discussions with investors regarding the refinancing of a private loan for former Yellow Pages publisher, Hibu Inc., but found low investor interest and was forced to cancel the offering.

This week, some corporate bond issuers, including Wells Fargo, Goldman Sachs, and JPMorgan Chase, saw their market trading prices lower than their issuance prices on Friday, indicating that next week's corporate bond issuers may need to provide more attractive terms for investors.

Media analysis points out that investment-grade bond yields have risen to the highest level since 2009, creating opportunities for investors who can withstand market volatility. Benoit Anne, Chief Strategist at MFS Investment Management, said:

Investment-grade bond yields are at a very attractive level for long-term investors.

Scott Kimball, Managing Director at Loop Capital Asset Management, stated that over the past decade, corporate bond issuance has had almost no competition with government bonds or mortgage-backed securities. However, this situation has rapidly changed, and all three markets are competing to provide more attractive returns for investors.Beach Point Capital's portfolio manager, Sinjin Bowron, said that if US bond yields continue to remain high, junk bond issuers will face the risk of having to significantly increase their interest rates. Bank of America estimates that the default rate for US companies may reach 5% next year.

The simultaneous strengthening of US bond yields and the US dollar is also rare in history

The surge in US bond yields has accelerated the demand for the US dollar. Since mid-July, when US bond yields started to rise rapidly, the US dollar has risen by about 7% against the currencies of the Group of Ten (G10) countries on average. The US dollar index, which measures the strength of the US dollar against six major currencies, recently reached a 10-month high.

UBS wrote in a recent report that during this period of rising US bond yields, the strengthening of the US dollar has pushed other currencies to structurally low levels. For example, the Japanese yen has fallen by nearly 8% against the US dollar to around 150, while the euro and the pound have both fallen by 6.1% and 7% against the US dollar, respectively.

However, the strengthening of the US dollar will further tighten the US financial conditions and may damage the balance sheets of US export-oriented and multinational companies. Globally, the strengthening of the US dollar will complicate the efforts of other central banks to curb inflation.

Analysts point out that the simultaneous strengthening of US bond yields and the US dollar is also rare in history. When the US dollar and US bond yields strengthen, it means that both domestic and international US dollar liquidity is tightening (reflected in the increase in cross-currency swaps and the reduction in the scale of foreign official institutions' holdings of US Treasury securities), which is unfavorable for assets priced in US dollars and emerging markets.

Analysts believe that it is worth noting that rapidly rising interest rates and the US dollar itself can also trigger risks, especially in weak areas with large interest rate exposures and high leverage. For example, small and medium-sized banks represented by Silicon Valley Bank have large unrealized gains and face significant pressure on deposit inflows, as well as commercial real estate or high-yield bonds, etc. These weak areas are more likely to become "black swans" in extreme market environments.