The sharp fluctuations in the bond market are quietly taking on the role of the Federal Reserve's tightening measures, and this rare pattern brings a new framework for interpreting the direction of the stock market.
Morgan Stanley's chief equity strategist, Mike Wilson, pointed out in the latest weekly report that as the yield on 10-year U.S. Treasury bonds has risen by 120 basis points since February, financial conditions have tightened significantly. In fact, the bond market is now taking over from the Federal Reserve in raising interest rates, which may mean that the Fed does not need to further raise policy rates. Wilson believes that if the U.S. Consumer Price Index (CPI) data released this Wednesday is modest, it will help ease the pressure on long-term yields and market expectations for policy rates.
In this context, Wilson provides investors with two forward-looking indicators: the relative performance of financial stocks, and the MOVE index, which measures bond market volatility. He emphasizes that changes in bond market volatility are more indicative than the absolute level of yields, and this week's third-quarter financial reports from JPMorgan Chase, Goldman Sachs, Citibank, and Wells Fargo will serve as key observation windows.
The tightening effect in the bond market has already become apparent.
In the report “Weekly Warm - up” released on Monday, Wilson pointed out that due to the combination of multiple factors, the effects of monetary tightening have begun to take effect in the market: the yield on 10-year U.S. Treasury bonds has risen by 120 basis points since February, the U.S. dollar index has strengthened, and oil prices have remained high. Together, these three factors constitute a substantial tightening of financial conditions.
Global government bond yields have currently exceeded 4% as a whole, for the first time since 2000. Wilson believes that, with the bond market already pricing in higher interest rates, the policy pressure faced by Federal Reserve Chairman Kevin Warsh has actually eased. If this week's CPI data does not show an unexpected increase, the upward momentum of long-term yields may tend to slow down.
The rise in the S&P 500 obscures internal divergences
Wilson points out that the reason why the S&P 500 index has not fully reflected the tightening of current financial conditions is that the index's gains are highly concentrated among a few large-cap technology stocks centered on artificial intelligence—these companies' growth potential is sufficient to withstand the impact of rising capital costs.
This structural differentiation is already evident across a wide range of the market. Since March, weight indices such as the S&P 500 have lagged behind market capitalization-weighted indices by 6 percentage points, indicating that individual stocks have been under greater pressure from rising long-term interest rates. Wilson emphasizes that for most stocks, the rapid increase in yields has caused substantial damage.
Two key signals determine whether the worst has passed
Wilson It is recommended that investors focus on tracking two indicators to determine whether market pressure has peaked.
One of them is the MOVE index, which is an indicator of bond market volatility. Wilson believes that what is truly important is not the absolute level of yield, but rather the rate of change in yield and its volatility. A decline in the MOVE index will be an important signal that the pressure on the bond market is easing.
The second point is the relative performance of financial stocks. This week coincides with the period when JPMorgan, Goldman Sachs, Citi, and Wells Fargo disclose their third-quarter results. Wilson believes that if the financial reports of these banks are robust, it will send a signal of a 'full relief' to a considerable extent.
Recession concerns or overpricing
Although Wilson acknowledges the risk that rising yields may evolve into a barrier to growth, he currently believes that this scenario has not yet materialized. He pointed out that this upward trend in yields is largely due to economic growth itself and the resulting demand for capital, rather than being driven solely by inflation or policy expectations.
From the perspective of real interest rates, by subtracting the current year-on-year rate of CPI at approximately 3.4% from the federal funds effective rate of 3.88%, the resulting interest rate spread is far lower than the peak levels seen before previous recessions. This indicates that the market's pessimistic expectations regarding growth prospects are possibly overestimated. Combining this with optimistic expectations for the upcoming earnings season, Wilson concludes that there is still room for improvement in the trend of the U.S. stock market.
