Rising Rate Risks: Why Bond Yields Could Upend the Rally

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Hello, this is Bob Dahl with Dahl's Deliberation for August 31st, Issue 6.35.
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Equity averages were mostly higher last week. Example S&P 500 up one half of
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one percent. However, the equal weighted S&P lagged and finished lower for the second straight week.
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Best sectors in the week were technology up 1.8 percent, communication services
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up 1.6, and financials up 1 percent. Worst sectors, energy down nearly 2%.
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Healthcare also down nearly 2%. Real estate down 1.25%.
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We have entitled our essay this week, Rising Interest Rate Risks Remain.
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The U.S. administration has not pivoted from taking short-term economic risks
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to pursue pro-growth policies ahead of the midterm elections as was expected.
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The result is that the still healthy U.S. economy now faces some mildly stagflationary forces.
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Further increases in tariffs and a still unresolved standoff in the Middle East
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are directionally inflationary and negative for growth.
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Globally, the impacts vary.
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Energy-importing economies are facing higher energy prices and less certain
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supplies than was the case at the start of the year Meanwhile,
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those countries most impacted by higher U.S.
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Tariffs face economic headwinds The risks are not yet significant enough to undermine the U.S.
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And global economic expansion As confirmed by recent, generally positive data
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in most economies The dilemma is that both the war and tariffs will reinforce
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the already existing upward pressure on global bond yields,
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The earliest warnings of a deteriorating economic outlook are usually found
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in the credit market, soon followed by weaker equity markets,
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However, even as absolute yields have risen modestly, investment-grade and high-yield
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corporate bond spreads remain historically low Albeit there is an early warning
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sign from the rising spread For the,
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lowest quality U.S. corporate paper.
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A flood of new corporate borrowing is a new and growing concern,
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especially since it is occurring at a time of ever-rising public sector debt issuance.
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The latter is a major longer-term concern since it is not occurring during a
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recession, but rather at a time when most economies are near full employment.
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As a result, the path of least resistance for global bond yields appears to be upward.
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Economic growth remains solid, inflation is sticky, and the demand for capital
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via debt markets will continue to grow rapidly In addition, a misguided attempt to lower long-term U.S.
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Government bond yields by Treasury Secretary Besant has only,
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intensified the upward pressure at the long end of the yield curve Offsetting
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the drag from higher government bond yields Credit and equity markets continue
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to benefit from still accommodative.
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Fiscal conditions And the support of rising corporate profits,
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Strong earnings growth is an unusual outside of periods of following recessions
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But there is now a high hurdle to continue outperforming elevated earnings expectations in the U.S.
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Profit growth is destined to decelerate in 2027 U.S.
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Economic and policy conditions are not conducive to bringing inflation down
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to pre-2020 levels I.e. down to the Fed's target of 2% While not related to
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higher tariffs An additional source of U.S.
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And global inflationary pressures Is coming from a previous and long-lasting
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source of disinflation Namely, China.
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Our 10 points for the week. Number one, July core PCE inflation came in at 0.25%
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month over month above the 0.20 consensus.
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This has been the Fed's favorite inflation indicator.
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Two, the U.S. economy continues to show resilience and remains a tailwind for earnings.
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The labor market is not creating demand-side inflation yet, and the capex boom,
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remains structural rather than cyclical, making it robust.
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3. Housing remains weak. Consumer confidence remains weak with sluggish services
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activity. However, manufacturing remains relatively buoyant,
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likely helped in part by the AI capex boom.
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4. Since the beginning of the war, China is a key linchpin in the Iran strategy.
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The blockade and secondary sanctions are hurting Iran, but China remains its economic lifeline.
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5. Iran does not need to close the Strait of Hormuz to exert control over it.
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Keeping the strait dangerous enough that insurers and commercial shippers restrict
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traffic may accomplish much of the same objective without a formal closure.
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6. The price for defending the Treasury market might be to sacrifice the dollar.
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However, the only permanent solution for the bond market is fiscal improvement,
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which is unlikely anytime soon.
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7. As of mid-August, the S&P 500's forward earnings were up 24.9% year-to-date
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versus a 12.1% gain in the index, which has pushed the forward P.E.
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Down 9.9%. 8. Forward earnings have risen almost interrupted this year 8.
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A key concern is likely to be the slowdown in earnings growth into 2027,
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given the elevated growth rates this year The deceleration from more than 30%
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growth to the low teens is beginning to attract attention 9.
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NVIDIA's earnings suggest that the AI spending boom is broadening AI-related
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investments should remain a significant tailwind for economic and earnings growth.
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10. Here's an interesting trio.
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U.S. public debt is more than 100% of GDP.
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The U.S. dollar is near a 25-year high. And profit margins are three standard
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deviations above normal.
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Our conclusion? The risk-on backdrop continues despite ongoing tensions in the
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energy market and U.S. tariff policies.
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These headwinds are stagflationary but have not been sufficient to slow the
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global economic expansion,
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Despite an early warning sign from the rising spreads on the CCC-rated debt,
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The overall credit market is historically calm and supportive of equity markets,
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The main risk for investors is the relentless rise in long-term bond yields,
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Rising credit demand, now including the corporate sector, increases the odds
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of an overshoot in bond yields Thanks, good luck, have a great week,
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That concludes this week's Dolls Deliberations. You now have our essential insights
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