Interest Rates Need To Back Off, Or Equities Will Have A Problem
Commentary Highlights:
Momentum and Tech getting Extended: The S&P 500 achieved a record high of 7,512 before a late-week reversal, exposing deep underlying market fragmentation. While mega-cap tech and semiconductors have driven a near-vertical momentum rally, the rest of the index is struggling under the weight of higher interest rates, a stronger dollar, and elevated oil costs. Investors are cautioned against chasing these stretched levels as the market heads into a seasonally weaker period, a new Fed Chair, and a mid-term election year all of which historically coincide with downside volatility.
Surging Interest Rates and the Central Bank Dilemma: The cost of money is breaking out globally, highlighted by the U.S. 10-year Treasury yield bursting above a three-year triangle formation to eclipse 4.60% and the 30-year yield hitting 5.13%. Policymakers are trapped in a toxic cocktail of persistent inflation, multi-trillion-dollar peacetime fiscal deficits, a massive AI capex cycle, and energy supply disruptions from the Iran conflict. Because these inflationary forces are driven by supply shocks and structural fiscal dominance rather than cyclical demand, the Federal Reserve's tools are too blunt to effectively intervene, forcing central bank officials to signal a "higher-for-longer" monetary stance.
Geopolitical Realignment and Long-Term Portfolio Strategy: The broader global macro environment is transitioning from a uni-polar world to a transactional, multi-polar order, highlighted by an inconclusive Trump-Xi summit that set the stage for a fragmented "G2" superpowers framework. This structural shift implies a permanently higher baseline inflation regime, dictating a portfolio allocation that favors equities and hard assets (like gold and select commodities) over paper assets over intermediate and longer horizons. However, because nominal yields have re-rated so aggressively, fixed income has become significantly more compelling, now offering a risk-free 10-year real return of 2.32%—among the highest real rates witnessed over the past decade.
Full Commentary:
While the S&P 500 narrowly finished in the black last week (+0.13%), the price action under the hood was anything but constructive. Let me rephrase – momentum and the high beta factors which the S&P 500 has become highly correlated to, given the expanding concentration in Mega Cap Tech and the Semiconductor sector, continued to rip, but most of the rest of the index subject to factors like higher interest rates, a stronger dollar, and higher oil prices came under considerable pressure: at the sector level, Consumer Discretionary (-3.05%), Materials (-2.5%), Real Estate (-2.66%), and Utilities (-1.9%) were hit hard, while the Russell 2000 Small Cap (-2.37%) and S&P 400 Mid Cap Index (-2.43%) succumbed to the pressure from these higher input costs.
Also weighing on the tape last week was the Xi-Trump meeting concluding with no clear message about the resolution of any urgent issues, despite many choreographed ceremonies and goodwill dialogues. Equity markets are in a vulnerable position at the moment, as a lot of optimism about the war in the Middle East and oil supply had been priced in over the past month. Not to mention a spectacular earnings season coming to a close, with expectations raised across the board for the remainder of the year. All time high S&P 500 earnings, profit margins, and AI being able to overcome everything thrown at it (yes, that’s more than a bit of hyperbole) is fully baked into equity markets with an S&P 500 trading to an all-time high of 7,512 on Thursday.
All the while, most systematic trading programs are back to fully long, sentiment has shifted back to the bull camp, yet volatility, as measured by the VIX, can’t seem to sustain a move below the 17 level. I’m going to run through some charts below to put this surge in the equity market since the end of March into context. Momentum stocks (dominated by semis) have basically had a vertical rally relative to minimum volatility stocks (think defensives like staples and utilities). It's not the move up that’s worrying; I’m in the camp that fundamentals back it up, but rather the steepness in the ascent. Historically, markets have difficulty maintaining straight-line moves (in either direction) like this one.
Last Thursday’s reversal could mark the beginning of the much-needed pause or correction. It is still early, and this isn’t an attempt to call a top, but rather a warning to those chasing up here – you’re late. You missed the move. Have patience and wait for a better entry point. We’re entering a seasonally weaker period for the stock market, with an avalanche of large IPOs that will represent a ton of new equity supply for the markets to digest. Oh, did I mention it’s a midterm election year, and the Fed is ushering in a new Fed chair, both of which historically coincide with a stock market correction? Below is a chart mapping out Fibonacci levels on the Nasdaq QQQ ETF, with the first technical support level around $680 (note the gap), with the next major support near $660. The 50-day moving average remains much lower, around $630.
Nvidia, the poster child of the AI revolution and the largest market cap company in the world, will be front and center this week as they report earnings after the bell on Wednesday. The stock, which had lagged other semiconductor companies, hasbeen in catch-upmode (up 7 days in a row into last Friday, +20% over this run) but has been lower on the day after reporting earnings following 4 of the past 5 prints, and hasn’t really delivered an outsized upside reaction on a print since May of 2022.
Meanwhile, other forces are at play. Remember when rates used to matter for tech? That narrative faded once investors realized mega-cap tech was sitting on enormous cash piles that were being reinvested at higher yields during the rising rates environment in 2022. But that was before the AI capex explosion era. Now we’re in an environment where rates are moving higher just as hyperscalers enter the most capital-intensive spending cycle in modern tech history, potentially reopening the old ‘rates-vs-tech’ debate at the exact moment positioning and momentum have reached extreme levels. Could the script be flipping again? The chart below plots the wide gap that has opened up between the meaningful rise in 10-year Treasury yields (inverted on the chart) and the Nasdaq Composite. To be fair, there have been disconnects in this relationship over the past year, but they’ve always mean-reverted in some fashion. I don’t suspect this time will be any different – either rates are too high and will come down, or the Nasdaq is out kicking its coverage and will be reined in by higher interest rates.
As for interest rates, the U.S. 30-year yield has reached 5.13%, and the 10-year is above the 4.60% mark. Rising yields and inflationary pressures are applying pressure on the U.S. administration to find a workable solution to get the Strait of Hormuz reopened. The higher-than-expected inflation prints in both CPI and PPI highlighted the toxic cocktail that policymakers and investors have to navigate at the moment. U.S. fiscal policy is running effectively unlimited fiscal deficits in peacetime (if we can still call it peacetime), alongside an AI capex boom (~$750bn 2026) heading toward trillions, and we top that off with an oil and supply shock to one of the globe's major shipping channels.
“Come on Corey, why do you concern yourself with such noise? The stock market is at an all-time high. I don’t know why you pay any attention to all this stuff that gets rendered irrelevant; stocks don’t care about it, so why should I?” Because they do care eventually, and when the price of money (interest rates) is breaking out globally, it matters to all asset prices. Last week the yield on the 10-year Treasury broke above the huge triangle formation it's been in for nearly three years.
Not to mention the 4.60% – 4.80% range is a huge psychological level for markets, as this is where Treasury Secretary Bessant stepped in during the tariff chaos last April to calm the bond market. We are not at that level of chaos yet, but we’re in the ballpark, and I, for one, would prefer not to get back to such an extreme.
It’s a similar story for the 30-year U.S. Treasury.
The unnerving narrative on this global interest rate move is that yields probably need to rise further to attract capital to fund increasingly stretched government balance sheets. Outside of a brief period following WWII, the U.S. federal government has never had such a thin buffer to support the economy. Now, to be fair, that hasn’t stopped policymakers from acting as if they do have an abundance of wiggle room ($2 trillion deficits as long as the eye can see), but such actions have consequences that play out over years and decades, not weeks and months.
One of those consequences is larger government deficits, which crowd out private-sector investment. Another is investors demanding higher term and inflation premiums, which exacerbates the over-indebtedness issue by increasing the interest burden while further expanding the deficit. This isn’t just a U.S. phenomenon either; the following chart from Torsten Slok at Apollo plots G7 government bond yields (Canada, France, Germany, Italy, Japan, the U.K., and the U.S.) reaching their highest levels since 2004.
The yield on the 2-year T-bill is up roughly +70 bps, the 10-year T-note +60bps, and the 30-year +50bps since the Iran conflict kicked off at the end of February. This drastic repricing higher of interest rates across the curve isn’t being talked down by Fed officials. Several Fed Presidents were on the speaking circuit last week delivering hawkish comments:
New York Fed Governor Williams said he doesn’t see “any reason at all to raise rates right now or lower rates now.”
President Collins said she is “particularly concerned about inflation,” thinks “it will likely be important to maintain the current slightly restrictive monetary policy stance for some time”, and “could envision a scenario in which some policy tightening is needed to ensure that inflation returns durably to 2% in a timely manner.”
Chicago President Austin Goolsbee highlighted services inflation as the “unexpectedly disappointing” part of the April CPI report and described the labor market as “stable but not good.”
President Schmidt said he sees “continued inflation as the most pressing risk to the economy.”
In short, rates will stay higher for longer, and investors should plan accordingly.
To finish with the bond market discussion: while inflation risks have risen at the margin compared with pre-war projections, and rate-hike probabilities are rising globally, the question the bond market must resolve is how monetary policy can realistically address a supply-shock-driven inflation problem. Monetary policy can affect cyclical demand and influence inflation expectations, but it cannot resolve a supply shock or supply-chain gridlock. It is also less effective in changing the course of inflation in non-cyclical sectors.
In a nutshell, monetary policy officials are in a bind as the tools at their disposal are too blunt and broad to combat the inflationary forces they are fighting. If they hike rates, they only further hurt parts of the economy that are already weak (housing, autos, anything interest rate sensitive), while at the same time hindering those parts of the economy that are preventing the overall economy from falling into a recession. One last point I want to make is that monetary policy is becoming less and less relevant in the era of fiscal dominance that commenced after Covid. With debts and deficits at current levels, Uncle Sam and the U.S. economy need a modest, stable interest rate regime to accommodate the financial system's growing dependence on financialization.
Let me try to summarize some thoughts to close out this week’s missive. At this juncture, I see the markets, policy makers, and government leaders playing a game of peek-a-boo with global interest rates. All are aware of the key levels rates are at, and all are hoping this is as far as they go on the upside. All prefer the optimistic narrative that rates are higher because economic growth is solid, we’re undergoing a once-in-a-generation AI boom, corporate earnings and profit margins have never been higher, and labor market fundamentals are improving.
This is all true and a validation for why you don’t bet against the U.S. economy. I'm willing to bet that, in hindsight, this administration would’ve preferred not to have ventured into the Iran conflict. Especially if they didn’t have the stomach to see it all the way through and effect the long-term fundamental change President Trump repeatedly professed that no other administration before him dared to do. Instead, we are where we are, in between a rock and a hard place, where the status quo cannot persist for much longer. I deliver these comments with respect and a huge dose of humility as I know all too well that hindsight is 20/20. But at the end of the day, all this administration needed to do for 2026 was stay out of the way and let the economy and markets do their thing.
Nevertheless, the long-term consequences from this war are likely to be profound… higher geopolitical risk premia, more expensive energy security, weaker confidence in global trade, and persistent pressure on food-importing countries will be felt across the globe for some time. International relations, even amongst NATO allies, are ruptured, while alliances in the Middle East (Saudi Arabia and the UAE) look set to re-align meaningfully. The disruption in energy markets puts even greater emphasis on stockpiling, investment in renewables/nuclear power, and friend-shoring broader supply chains.
These shifts all suggest a higher inflationary regime for longer. Here we can tie in the first of four potential meetings between Trump/Xi, where nothing actionable came out of this one, but it seems as though the table is being set for an eventual truce between the world's two major superpowers – a G2 world as Trump calls it. A world where the U.S. and China can agree to agree and agree to disagree while retaining a level of respect and understanding of the other side isn’t a bad world. To me, these are all incremental checkpoints along the path of transition from a uni-polar world to a multi-polar world. The world is going back to an order that is transactional on the basis of a nation's own self-interest, with a standard set of global values and rules deprioritized.
As for markets, this is as simple as I can frame it:
I prefer stocks over bonds over an intermediate and longer-term time frame. AI is real, investable, scary, and likely leads us into an equity bubble. I don’t think we are there, but it should be in the back of all our minds.
I prefer gold, hard assets, and select commodities over bonds in the intermediate and long-term. Until government leaders from around the world find some semblance of fiscal probity, real assets should continue to outperform paper assets (bonds and cash) over most intermediate to long-term durations. However, outside of gold, I don’t view any commodity as a buy-and-hold investment forever. Even gold has its shortcomings in certain environments, as it doesn’t generate earnings or cash flows. Commodities are cyclical assets governed by supply, demand, and technological advancement, which is always encroaching on their intrinsic value or seeking to render them less valuable.
As for bonds, let's just say that as yields rise to the levels they are getting to at the moment, they become much more interesting to own in portfolios. A 4.6% yield on a 10-year T-note with the 5yr5yr forward inflation expectation rate at 2.28% is a real return of 2.32% with no credit risk. This is near the highest real rate in the past decade.
Most importantly, investors need to understand the difference between what they ‘need’ and ‘what is nice to have’ in terms of portfolio returns. We’re all guilty of opening our finance app at any given moment to take an hourly, daily, or weekly marking to market of our investment portfolios. It's not a bad thing to be aware of, but it has created a level of short-termism, return entitlement (given the stock market has mostly marched higher over the past 17 years), and introduced financial goals that were never considered a decade ago. I’m not preaching, nor scolding, but rather encouraging some to find hobbies outside of tracking their net worth on an hourly basis.
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