INTEREST RATE RISKS

Despite the recent uptick in stock prices, the trend in interest rates is concerning.

The 10-year Treasury yield touched 4.747%, right around its highest level in the last 20 years. The 10-year reached 4.9% in 2023 and 5.0% before the Great Financial Crisis in 2007. The 30-year reached 5.274%, a 19-year high last seen in July 2007.

The Treasury market sets part of the price of almost everything you own. It influences mortgage rates, corporate borrowing costs, bond prices, and the rate investors use to value future corporate profits.

When yields rise, existing bond prices fall. Borrowing becomes more expensive. And the distant profits supporting expensive growth stocks become less valuable today.

The bond market has two things weighing on it right now. The first is domestic: investors are questioning whether the Federal Reserve is doing enough to control inflation. The second comes from abroad: Japan's effort to defend the yen may require it to mobilize part of the world's largest foreign Treasury position. We don't yet know how many Treasuries Japan actually sold — but its intervention landed at exactly the moment the U.S. bond market was already losing patience.

The Treasury market sets part of the price of almost everything you own. It influences mortgage rates, corporate borrowing costs, bond prices, and the rate investors use to value future corporate profits.

Why 5% Matters to Your Portfolio

The 10-year Treasury yield is one of the market's most important hurdle rates — the return threshold every other investment gets measured against. It shapes mortgage rates, corporate borrowing costs, and the rate investors use to discount future corporate profits back into today's dollars.

When the 10-year rises, three things happen at once: existing bond prices fall, financing gets more expensive across the economy, and every distant dollar of expected corporate profit becomes less valuable today. That last point matters most for expensive growth stocks — a large share of their value depends on profits investors expect years from now, and the higher the discount rate, the less those future profits are worth in present dollars.

A 5% 10-year rate is not a guarantee of future economic problems, but it puts pressure on all financial markets. At a 5% Treasury yield, investors can earn a meaningful return without accepting corporate earnings risk at all. That forces expensive stocks to offer a more convincing growth story — or a lower price. Government bonds compete more aggressively with stocks for investor dollars, housing affordability deteriorates further, and high-multiple companies have much less room to disappoint.

The historical parallel is useful if held carefully: the 10-year also touched 5% in October 2023, when the S&P 500 was near a five-month low, and stocks rallied hard once yields retreated. That was a correlation with several contributing causes, not proof that 5.00% exactly is some mechanical trigger for a selloff — but it's the same test the market is running again.

The Bond Market Was Already Revolting

The more important cause of Friday's Treasury selloff was domestic, not Japanese. The Fed held rates steady this week despite three officials preferring a quarter-point increase. In response, short-term yields fell while long-term yields rose. In this case, the front end of the yield curve was pricing less additional Fed tightening, while the long end demanded more compensation for the inflation risk of holding debt for decades.

In plain English, the market was saying: the Fed may not raise short-term rates enough, so investors want more compensation for holding long-term bonds exposed to inflation. That's a credibility warning. Japan didn't create it. Japan may have simply arrived at exactly the wrong moment.

The Bond Investor's Case Against a Silent Fed

A bond vigilante is an investor who sells government bonds because they believe fiscal or monetary policy is too loose. That selling pushes yields higher, tightening financial conditions even when the central bank does nothing. The vigilantes don't literally set the Fed's policy rate. They can set the borrowing rate the rest of the economy actually feels.

Fed Chair Kevin Warsh has largely abandoned the forward-guidance crutch — the hints about the Fed's next move that prior chairs leaned on. Three voting officials — Cleveland's Beth Hammack, Dallas's Lorie Logan, and Minneapolis's Neel Kashkari — wanted a quarter-point hike. The Fed held anyway, 9-3, keeping the target range at 3.5%-3.75% for a fifth consecutive meeting. The long end sold off anyway.

The inflation backdrop makes the hold harder to defend.

Japan's Currency Defense

Japan is the largest foreign holder of U.S. Treasury securities specifically, at roughly $1.14 trillion as of the latest available monthly data — its broader foreign-exchange reserves are larger, with Treasuries making up a substantial share. Japan does not necessarily need to dump Treasuries to obtain dollars: it can draw down dollar cash, sell other dollar assets, or borrow dollars against Treasury collateral through a Federal Reserve facility built for foreign central banks, which lets it raise dollars without selling a single bond.

That means we don't actually know how much long-duration Treasury paper, if any, Japan sold outright Friday. It's a potential source of pressure on the world's largest bond market — not a confirmed cause of last week's selloff.

The honest conclusion is that the U.S. bond market was already questioning the Fed. Japan may have just added to the pressure.

What This Means for Stocks

Growth stocks rebounded on Friday and Monday, but higher bond prices will put downward pressure on tech stocks in particular.  If rates pause at these levels and then turn lower, that would be a good thing. 

When inflation and interest rates rose in 2021 due to Covid driven inflation, growth stocks began falling in November of 2021, preceding the bear market of 2022. The S&P 500 declined 25% in 2022 and the Nasdaq (tech) fell by 34%.

Oil prices are not making much sense now, but the recent decline back to $80 per barrel is good for stocks and inflation.

These recent moves illustrate why I am not a believer in bonds as an investment.  In 2026, bond prices have declined between 3% and 8% depending upon the duration.  The risk of loss combined with low rates of return is not a good tradeoff. 

Stay Disciplined My Friends,

Phil

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