A rate hike may be required to calm the U.S. bond market
Warsh is facing rising inflation and now a renewed energy crisis. He may face an uncomfortable dilemma: hike now to reassure bond markets or keep the stock market happy by leaving rates unchanged?
Bond markets are struggling. The real yield on U.S. 30-year Treasury bonds is 3%, the highest since November 2008 and the depths of the global financial crisis. For markets to focus on earnings growth positives, rather than the negatives of tighter financial conditions, new Federal Reserve Chairman Kevin Warsh needs to hike.
But will he?
In his weekly Flow Show strategy note, Bank of America's Michael Hartnett ponders the likelihood of Warsh imposing a rate hike to calm the long end of the Treasury curve. At present, he notes that markets ascribe a 38% probability of a Fed rate (FF00) rise next week, but have fully discounted one by the time of the Sept. 16 meeting.
The dilemma, though, is whether what Hartnett describes as an "equity-friendly" administration will allow such a tightening to "tamp brakes" on stocks in the run-up to the midterm elections in November.
Irrespective of what Warsh and the administration agree, though, financial conditions are tightening, he said. There have been 23 central-bank rate increases so far this year and Bank of America forecasts another 18 between now and year-end. Although Warsh disfavors the Fed forward guidance and dropped it, the consumer-price index is growing at a lick of 3-4%, the labor market shows no signs at present of AI disruption and the overall approach of investors to asset allocation would still appear to be best summarized as "anything but bonds," said Hartnett.
The paradigm observed most recently has been a rise in bond yields BX:TMUBMUSD30Y accompanying a rise in banking stocks, but he can see that flipping to higher yields and lower bank share prices XLF, triggering a deleveraging in risk assets. The best hedge against this is to buy the dollar DXY, Hartnett argues. Higher interest rates would theoretically increase the yield differential between the U.S. and other bond markets, attracting inflows to Treasurys.
That semiconductor stocks SOX have declined by a fifth from their June peak is a lead indicator for the industrial cycle - of AI, that is - and explains why the Magnificent 7 big tech stocks MAGS are struggling to hold on to their 200-day moving average. For now, Hartnett and his team of Jessica Guo, Anya Shelekhin and Myung-Jee Jung recommend exposure to defensives, dividend plays, duration asset or essentially longer-term bonds TLT, while disfavoring banks, brokers, tech XLK and industrials XLI.
"Blue collar" semis...lead indicator for industrial cycle (Texas Instruments, Analog Devices, NXP, Microchip, ON, STMicroelectronics
Hartnett draws a worrying analogy between the constraints imposed by the disruption to oil supplies and the uninterrupted supply of both U.S. Treasury bonds and U.S. stocks.
Quantifying this contrast, 64 million barrels of crude (BRN00) passed through the chokepoints of Hormuz and Bab el-Mandeb daily before hostilities broke out. Meanwhile, the U.S deficit of $2 trillion is generating an interest bill of $1 trillion annually. When it comes to equities, with AI capex turning large parts of the S&P 500 cashflow-negative, there will be fewer buybacks going forward, Hartnett contends.
Oil transit of around 64 million barrels per day through "chokepoints," but there are no chokepoints on bond and equity issuance, says Bank of America.
For this reason, Hartnett sees the logic in gold (GC00) and bitcoin (BTCUSD) stabilizing of late, which is why he thinks those assets will outperform Wall Street over the remainder of this decade
-Jules Rimmer
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(END) Dow Jones Newswires
July 24, 2026 08:53 ET (12:53 GMT)
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