Here’s a funny thought. What if the very thing that saves Wall Street from another beating ends up being the thing that sends Treasury yields soaring again? I know, that sounds rather convoluted but hear me out.
Think back to the last two weeks, where we have seen Treasuries enjoy a decent bid lately as investors seek shelter from the growing concerns surrounding AI spending, credit risks, and now the political fallout from the US midterm elections. 10-year yields have fallen back to near 4.90% and have stuck around there since.
Then now, we start to see a Democratic sweep take hold and that puts the focus back on tech stocks once again. The anti-AI and anti-data centre campaigning that helped shape the midterms is now taking over as the one of the core messages from the election results. At first glance, that looks to be quite a headache for tech stocks, no? I mean, slower infrastructure expansion will serve to threaten the growth projections that investors have been banking on.
That being said, what if a little restraint is exactly what the AI trade needs?
After months of investors questioning whether big tech are spending too much and too quickly, perhaps a more measured approach could actually be welcomed. That means less aggressive capital expenditure, which in turn would mean less pressure on borrowing and cash flows. And perhaps more importantly, it will get investors to stop pining over the uncomfortable question of when all that AI investment will start paying off.
Of course, there’s a fine line between spending discipline and undermining future growth. But if Wall Street eventually sees the former rather than the latter, equities could find some bit-part relief from the midterms.
If so, a recovery in risk appetite would take away some of the safe-haven demand supporting Treasuries amid heightened AI credit risks in the past few weeks. And that could potentially allow yields to refocus on the inflation pressures and fiscal concerns that have dominated much of the past two months.
However, there is a caveat to all this. And that is Trump decides on what he wants to do with the war against Iran.
After suffering a humiliating defeat in the midterms, Trump now faces the awkward reality that his presidency is going to be one that is defined by the war. So, does he seek an exit or will he double down to avoid looking weak after getting his ego bruised?
Well, I wouldn’t dismiss the possibility of the latter – even if a more hostile Congress complicates his options.
Taking that into consideration, another escalation could send oil prices higher and in turn revive inflation fears while pushing Treasury yields back up despite the geopolitical uncertainty.
As such, I would argue that the key for the next move in Treasury yields will come from fading safe-haven demand or renewed inflation fears. But either way, I wouldn’t be too quick to assume that the latest rally in the bond market has much further to run. That unless Trump decides to concede and pull back from the Middle East. Now, wouldn’t that be something?
This article was written by Justin Low at investinglive.com.