Hello, this is Kimama na Yaasu.
Entering September, the main focus of discussion in the financial markets has shifted entirely to the ‘rise in crude oil prices’ and the accompanying ‘further rise in U.S. long-term interest rates (yields).’ For a time, expectations of rate cuts due to cooling inflation had enveloped the market, but currently, inflation concerns are reigniting, and at the same time, the focus is shifting toward the astonishing resilience (growth story) of the U.S. economy.
With the U.S. 2-year Treasury yield approaching or reaching extremely high levels of 5% and the 10-year yield at 5.2%, what market participants are most concerned about is the point: ‘When will this rise in interest rates become a destructive headwind for the U.S. stock market?’
Furthermore, complex variables are intertwined in the current market, such as geopolitical risks surrounding the Middle East situation, political speculation ahead of the U.S. midterm elections, and the resilience of the high-tech and semiconductor sectors that are driving the U.S.
This time, based on the latest discussions from Bloomberg and global macroeconomic data, I will thoroughly unravel the true nature of the interest rate hikes led by rising oil prices, the reasons why U.S. stocks are not collapsing, and the outlook for the financial markets going forward, using only pure text, from both quantitative and qualitative perspectives, in a volume of approximately 6,000 characters.
1. Interest rate hikes led by rising oil prices and the establishment of a ‘geopolitical premium’
The greatest driving force behind the rise in yields in the current bond market is undoubtedly the re-soaring of energy prices.
Last week, in the crude oil market, there was a temporary sell-off due to faint expectations that ‘some kind of agreement might be reached between the U.S. and Iran, leading to an increase in supply.’ However, those expectations vanished in an instant due to reports that poured cold water on them over the weekend.
Prolongation of the stalemate and its impact on the midterm elections
Looking at political statements and foreign policy stances, including those of former President Trump, a direction of further strengthening economic pressure on Iran is being indicated. This strongly suggests that rather than the blind spots of geopolitical risk in the Middle East being resolved, we are entering a long-term stalemate.
Some market participants had an optimistic view that ‘there might be policy intervention (easing measures) to lower gasoline prices to suppress voter dissatisfaction ahead of the U.S. midterm elections.’ However, the current geopolitical dynamics are shattering that hope. Furthermore, there are even reports of risks that military actions and restrictions against Iran will be resumed and strengthened after the midterm elections, and a structure where a ‘risk (escalation) premium’ is constantly added to crude oil prices has become established.
The upward pressure on not just crude oil, but refined petroleum products as a whole, also casts a shadow over price indicators such as the PCE (Personal Consumption Expenditures) deflator to be announced this week. Even if soft numbers appear temporarily due to annual revisions, as long as there are concerns about the resurgence of inflation caused by high energy prices, it can be said that the decline in interest rates (rise in bond prices) is likely to be extremely shallow and temporary.
2. Two reasons why U.S. stocks are not collapsing even in a ‘world of 5% yields’
Here, I return to the opening question. Despite the U.S. 2-year Treasury yield exceeding 5% and the 10-year yield rising to the 5.2% level, why is the U.S. stock market avoiding a fatal crash and maintaining its strength?
The reasons can be broadly summarized into two types of ‘exceptionalism.’
Reason 1: ‘U.S. economic exceptionalism’ supporting the rise in real interest rates
When interest rates rise, if it is caused by ‘bad inflation’ (price hikes solely due to supply shocks), it deals a devastating blow to stock prices. However, the majority of the current rise in yields is a rise in ‘real rates,’ and behind it exists an overwhelmingly powerful U.S. economic activity.
What various PMIs (Purchasing Managers’ Indexes), employment statistics, and GDP forecast models show is the fact that while Europe and China are struggling with sluggish growth, only the U.S. economy continues to expand strongly. It is precisely because strong economic activity is supporting corporate earnings that companies are able to absorb high interest rate levels.
Furthermore, the specific route through which rising interest rates crush the stock market is the ‘tightening of financial conditions,’ but if you refer to objective indicators such as the Bloomberg Financial Conditions Index (FCI), the current U.S. financial environment is still in a ‘looser’ territory compared to the past one-year or five-year averages. In other words, even if the nominal government bond yield is at a high level, from the perspective of overall market funding and credit contraction, it has not yet reached the stage of a fatal tightening.
Reason 2: ‘High-tech exceptionalism’ driven by AI and semiconductors
In addition to the strength of the economy as a whole, there is another powerful engine in the US market. That is ‘Tech Exceptionalism,’ centered on the AI (artificial intelligence) boom and the semiconductor industry.
Looking at the market last week, mega-cap and semiconductor-related stocks such as Nvidia and Micron Technology strongly drove the entire market. Entering the fourth quarter (Q4) is historically and seasonally a very high-performing period for US stocks, and it also coincides with the earnings season for major companies.
In preliminary analyst forecasts (prop estimates), the earnings outlook for major tech companies is extremely robust. Because a structure has been formed where overwhelming profit growth (innovation) surpasses the fear of rate hikes and high interest rates, the stock market is easily leaping over the high barrier to entry of a ‘5% yield’.
3. UK Gilt Market and Political Noise: Look to the Persian Gulf, Not Liverpool
When we turn our eyes to macro markets outside the US, particularly the UK government bond (gilt) market, even more interesting facts emerge.
In the UK, domestic political debates and noise, such as the Labour Party conference held in Liverpool and the high-cost social care policies presented by politicians (high-cost fiscal spending plans looking toward the 2029 election pledges), are making headlines every day.
However, what is truly important in moving the yields of the gilt (UK government bond) market is not what is happening in Merseyside (domestic UK politics), but what is happening in the Persian Gulf (the Middle East oil market).
Politicians are trying to appeal to fiscal discipline and keep a low profile to avoid market turmoil, but in the face of the massive wave of global energy inflation, the influence of one country’s political performance is extremely limited. This shows the importance for investors, when predicting the future of government bonds and interest rates, to focus on the fundamental fundamentals (signals) of the oil market without being misled by domestic political performance (noise).
4. Future Outlook: Quantitative and Qualitative Evaluation
From here, based on the current battle between high oil prices, high interest rates, and US stocks, we will delve deeply into the outlook for the global financial market from two perspectives: ‘quantitative evaluation’ and ‘qualitative evaluation’.
Quantitative Evaluation (Market Critical Points Seen from Numerical Values, Indicators, and Probability Models)
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Limit Values for US 10-Year Treasury Yields (5.25-5.50%) and Stock Valuations While the US 10-year Treasury yield is currently around 5.2%, the quantitative limit level (critical point) is estimated to exist in the 5.25% to 5.50% range. The ‘yield gap,’ which is the difference between the S&P 500 earnings yield (the reciprocal of the P/E ratio) and the 10-year Treasury yield, is currently approaching near zero, recording a historical low (relative decline in stock value). If the 10-year Treasury yield clearly breaks through 5.50%, the bond yield’s attractiveness will outweigh the expected return on stocks, and the probability that large-scale portfolio reallocation (rebalancing sales) from stocks to bonds by algorithms and institutional investors will be triggered based on quantitative rules will rise to over 70%.
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Financial Conditions Index (FCI) and Credit Spread Thresholds The quantitative flag that triggers a stock market crash is the Bloomberg Financial Conditions Index shifting into a tightening territory of ‘+1.0 sigma or more from the 5-year average.’ Also, when the ‘credit spread,’ which is the yield difference between high-yield bonds (bonds of highly indebted companies) and government bonds, expands beyond 400 basis points (4%), it is the signal for a true stock market adjustment caused by the inability to refinance corporate debt. Currently, the spread is hovering in the low 300bp range, and no quantitative collapse signal has appeared.
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Oil Price (WTI) Inflation Spillover Point ($95-$100) If WTI crude oil futures exceed $95 per barrel and that state is maintained for one quarter (3 months) or more, the US headline CPI is estimated to resurface to the high 4.0% range year-on-year. If this quantitative figure is achieved, ‘additional rate hikes’ or ‘Higher for Longer’ interest rates by the FRB (Federal Reserve Board) will be confirmed, and the nature of the interest rate rise will transform from ‘growth-driven’ to ‘evil inflation-driven’.
Qualitative Evaluation (The Future Seen from Macro Structure, Market Psychology, and Geopolitical Risks)
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Qualitative Resilience and Vulnerability of ‘US Economic Exceptionalism’ Qualitatively, the US’s superiority compared to other countries (Europe, China, emerging markets) has not wavered. Because it possesses vast domestic demand, energy self-sufficiency, and the world’s most advanced AI technology infrastructure, the structure where global funds ‘concentrate in the US by process of elimination’ continues. However, hidden behind this structure are qualitative risks such as the ‘unilateral strength of the US dollar’ and the ‘exhaustion of other countries’ economies.’ When other countries’ purchasing power declines and the dollar’s high level begins to pressure the overseas sales of US companies, it is necessary to be aware of the risk that the ‘exceptionalism’ that has been a strength until now will suddenly turn into the limits of winning alone.
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‘Normalization’ of Geopolitical Risk and Structural Changes in Supply Chains Middle East situations and US-China confrontations are no longer ‘temporary events’ but have become established as ‘structural conditions (structural parameters)’ of the global economy. The costs of supply chain restructuring (nearshoring/friend-shoring) and energy security will continue to act as chronic inflationary pressure qualitatively. Because of this, it is impossible to return to the era of ‘low interest rates and low inflation’ as in the past, and investors are forced to build portfolios based on the premise of ‘high interest rates and high volatility’.
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Shift in Market Psychology from ‘Rate Cut Longing’ to ‘Earnings Growth Conviction’ Investor mentality (qualitative psychology) has completely shifted from a central bank-dependent stance of ‘when will the FRB cut rates’ to an emphasis on the company’s inherent competitiveness, asking ‘which companies can grow their profits on their own even in a high-interest-rate environment.’ Due to this psychological change, mere theme stocks and non-dividend growth stocks will be excluded, and selective investment in ultra-large tech companies (mega-caps) with robust cash flow and overwhelming market dominance will further accelerate.
In Conclusion: How Investors Should Position Themselves in Q4
Amidst the strong headwinds of rising oil prices and rising interest rates, the resilience shown by the US stock market is not mere optimism, but a reality supported by ‘real growth’ and ‘AI innovation’.
However, in a world where yields remain above 5%, there is always the latent danger that slight changes in parameters—such as crude oil exceeding $100 or a sudden tightening of financial conditions—could trigger a storm of volatility in the market.
The actions we should take are clear.
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Instead of being frightened by superficial interest rate hikes and immediately dumping stocks, calmly determine whether that rise in interest rates is due to a ‘strong economy’ or ‘bad inflation’.
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Eliminate companies with low capital adequacy ratios that cannot withstand high interest burdens from your portfolio, and shift your focus toward high-tech exceptional companies that boast overwhelming cash flow or the energy sector.
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Do not be swayed by noisy political news or short-term reports, but continuously monitor the ‘essential indicators’ of crude oil prices and financial condition indices.
Market volatility is expected to increase further toward the fourth quarter. That is precisely why you must draw up objective, emotionless scenarios in advance and faithfully execute your own investment plan. That is the only way to win in this complex and rapidly changing financial market.