The "anchor of global asset pricing" is no longer dormant! The "Powell era" of the Federal Reserve has begun, reshaping the yield curve in the "AI bull market" storyline.

With Powell's term ending, Kevin Warsh, nominated by Trump, officially took over the Federal Reserve from this week. However, due to the geopolitical storm in the Middle East and the economic boom brought about by the AI infrastructure construction frenzy and the surge in stock portfolio returns of high-net-worth groups in the United States, bond investors are betting that he will prioritize maintaining the Fed's reputation for fighting inflation rather than responding to President Trump's calls to lower interest rates. In addition, some Wall Street bond market strategists believe that even if the US and Iran reach a peace agreement for a period of time and the Strait of Hormuz reopens, market tightening expectations and the recent severe volatility in global financial markets, have a "global asset pricing anchor" 10-year US Treasury bond yields or longer-term US Treasury bond yield curves may not necessarily fall quickly, mainly because the current upward trend in longer-term yields is not solely driven by inflation expectations, but more from the rise in real yields, growing concerns over the sustainability of US debt, and the AI investment boom pushing up capital market financing demand. These potential trends also imply that the rising discount rates for discounted cash flow (DCF) will put long-term high valuation technology stocks associated with AI computing under "re-pricing pressure." The 10-year US Treasury bond as the risk-free rate anchor in DCF stock valuation models, once sustained at high levels, the AI bull market may not necessarily end, but will shift from an "valuation expansion bull market" to a "profit validation bull market." With the most significant surge in inflation data since 2023 caused by the Middle East Iran war, global bond market traders are actively pricing in the trend that the Fed is almost certain to start raising interest rates before December, with bond traders almost 100% pricing in a 25 basis point rate hike by the Fed before December. This marks a stark reversal from just three months ago when the market was betting that under Warsh's leadership, the Fed would be more likely to cut rates substantially. This shift reflects the impact of geopolitical turmoil, the resilience of the US economy, and the AI investment boom driving stock market gains; all of these factors have increased concerns that inflation may remain above the Fed's 2% target for some time. In a volatile trading week, the US 2-year Treasury bond yield - which is most sensitive to Fed policy expectations - surged to 4.14% last Friday, its highest level in over a year and nearly 40 basis points above the upper end of the Fed's benchmark rate range. The 30-year US Treasury bond yield briefly reached 5.2% last week, the first time since 2007, then fell back to 5.06%. The 10-year US Treasury bond yield, known as the "global asset pricing anchor," also rose to around 4.7% before falling back to around 4.5%. As shown above, the 2-year yield broke above the key Fed rate benchmark. With more Fed officials abandoning dovish policy inclinations, Warsh officially taking office and beginning to take charge, FOMC monetary policy voting member Christopher Waller appointed by Trump and a Fed Board member argued earlier this year for rate cuts to protect the US labor market, said on Friday that the Fed's next move might be to raise rates, in line with others who have recently shifted to a hawkish stance. When Warsh was sworn in on Friday, there was no continued pressure from Trump, who had been pressuring the Fed to cut rates, and instead emphasized that he wanted Warsh to lead the central bank independently. The market seems to have priced in an aggressive rate hiking scenario for the Fed for the year? Some funds are seeing short-term US bond investment opportunities It is worth noting that with yields rising significantly in recent days and the market seemingly overpricing Fed rate hike expectations, some senior bond market investors, including Chitrang Purani, a portfolio manager at Capital Group, are taking a more bullish stance on short-term US Treasury bonds. Purani said, "I do believe that the threshold for rate hikes remains quite high, as this 2027 Fed FOMC voting member and Fed Chair might want to be more patient with policy positioning before taking the next key monetary policy step to fully understand how inflation is passed through to the labor market and financial market trading conditions." "I personally do not think that with Warsh at the helm, the Fed's reaction function to economic data will be substantially different from the past." The Japanese government bond market is a typical example: Stronger than expected domestic inflation and economic growth, the possibility of further rate hikes by the Bank of Japan, additional government budget concerns, reductions in ultra-long-term Japanese government bond asset allocations by life insurers, all contributed to the sharp rise in the Japanese government bond yield curve; however, Pacific Investment Management Co., one of the world's largest fixed income investment giants, believes that "bearish pricing" has gone too far, with the 30-year term offering excessively high compensation relative to the 10-year term, therefore choosing to hold onto longer-term Japanese government bonds with maturities beyond 30 years. In contrast to the expectations of economists, the bond market had been pricing in a Fed rate hike by the end of the year. Economists overall outlook on interest rates remains mild, continuing to view the inflation sparked by the energy price surge following the outbreak of the Iran war two and a half months ago as temporary and unlikely to spread more widely to other consumer prices. According to a survey conducted from May 14th to 19th of 101 economists, nearly 85% (83) expect the benchmark rate to remain unchanged between 3.50% and 3.75% before the third quarter. This proportion was slightly above half the previous month and close to 70% in March, where at least one rate cut was expected by then. As for year-end rate levels, economists have not yet formed a clear consensus, but nearly half of them (49 out of 101) expect no rate adjustments by the Fed this year, higher than the previous one third. Nearly a third expect one rate cut this year, with most anticipating it in December. Only four economists expect the Fed to hike rates before December. In addition to reading between the lines of speeches by Fed officials, bond traders will also be keeping an eye on the sale/auction of 2-year, 5-year, and 7-year US Treasury bonds this week, looking for any signs of demand from global institutional investors for US Treasuries. War may cease, but yields may not fall! As the Warsh era begins, the US bond market seems to enter a "long bond high yield" era Over the weekend, there were reports that the US and Iran were close to reaching an agreement that would extend the existing ceasefire by 60 days, during which the Strait of Hormuz would reopen, and Iran would be allowed to sell its oil. However, as both sides are still negotiating the exact wording of key issues, no document will be signed at this time, and final approval may take several days. The "bond vigilantes" are sending a reverse signal to Trump's call for lower rates: If Warsh prioritizes maintaining the central bank's anti-inflation credibility, the short-term yield will be supported by rate hike expectations; while the record fiscal deficit, AI data center debt financing, and higher natural rates will continue to suppress long-term US bond trading. This means that the long-term US bond market faces not only a simple geopolitical shock but also a deeper global savings-investment balance reassessment: While war may cease, a high yield environment for long-term bonds may persist. Although anxiety surrounding inflation concerns related to the war is high, there are signs that other driving factors will also have a significant impact on longer-term borrowing costs. In the US, the so-called real yield curve - the yield after inflation has been stripped out - has had a greater impact, indicating that bond investors are not only concerned about the price pressure brought about by the US-Iran war. Other factors include: signals showing that the already large public debt burden will expand further; the effects of the unprecedented AI investment boom; and the rising possibility of central banks, including the Fed, raising rates instead of cutting them. Jonathan Hill, head of US inflation strategy at Barclays, said, "The claim that global long-duration assets are being sold off due to inflation expectations is difficult to match with the pricing of medium-term inflation risks in the market." "It is more likely that rising debt levels, potential higher neutral rates, and the interaction of massive AI investment will continue to push real yields higher." The so-called neutral interest rate is a level of interest rates that neither stimulate nor suppress the economy. While rising oil prices may dominate the headlines, the balance inflation rate, which measures the market's expectation of inflation risks over the medium term, has not increased as much as overall yields in the US and UK. Hill pointed out that even with ongoing war, the US 10-year balanced inflation rate is still about 50 basis points lower than in the first half of 2022, when the Fed was raising rates significantly. The so-called 5-year, 5-year breakeven inflation rate - a key proxy for medium-term inflation expectations in the market - is around 2.2%, roughly at the level it was last December. As shown above, the major global bond markets have different drivers of high yields. Data shows that in Japan and Germany, the rise in the balanced inflation rate since the start of the war has explained most of the increase in 10-year bond yields. Europe as a whole is facing higher natural gas prices, while Japan's inflation pressure was already rising even before the war broke out. Now, analysis reports suggest that the Bank of Japan's reluctance to raise rates is forcing investors in the Japanese bond market to seek more compensation to absorb inflation risks. Subtracting the inflation-adjusted yield from the nominal yield, the remaining yield is the real yield; some market participants believe that the real yield is a more accurate measure of borrowing costs. An analysis report from Bloomberg shows that in the US, the rise in real yields explains most of the overall increase in yields, while in Japan and Germany, inflation is the main influencing factor. Padhraic Garvey, head of research for the Americas at ING, said that such trades mean that even if the Strait of Hormuz - a critical artery for global energy flows closed due to the war - reopens, the actual yield rates remain high; if so, then long-term bond yields "might stay a little sticky at high levels." He believes that nearly all of the spike in the US 10-year bond yield to above 4.5% comes from the rise in real yields. The benchmark 10-year US Treasury bond yield reached nearly 4.70% on Tuesday, before falling back to 4.56%. As depicted above, the surge in US Treasury bond yields is primarily driven by the rise in real yields. Garvey said, "Reopening the Strait of Hormuz may suppress inflation expectations but may keep real yields high; if so, US bond yields will not fall sharply as many currently expect." Mark Malek, Chief Investment Officer at Muriel Siebert & Co., wrote in a report to clients, "The bond market is not reacting to a single news headline." "It's repricing a structural issue, not something that can be resolved by a news release or a short-term ceasefire agreement." In early Asian trading on Monday, oil prices fell, while US Treasury futures edged higher. The global benchmark Brent crude oil fell 5.2% to $98.12 per barrel at one point, while WTI crude oil approached $92. In an era of high yields for long-term bonds, severe fluctuations in global risk assets such as technology stocks may become the norm Jamie Dimon, CEO of JPMorgan Chase, known as "Wall Street's King," said in a media interview last week that US interest rates could further rise significantly, citing concerns about government borrowing and debt demand. Phillip Lee, in charge of sales of real-money interest rates at Goldman Sachs, said that with continued fiscal deficits, more US Treasury issuances, and concerns over debt sustainability, it is increasingly explicable why investors demand additional risk premium for longer-term US Treasury bonds - that is, more "term premium" to hold 10-year and longer US government bonds. He said on a Goldman Sachs podcast, "I believe the yield curve will move higher." The rise in real yields, expanding fiscal deficits, the absorption of savings by AI capital expenditures, the increase in long-term bond supplies, and the Feds possible emphasis on maintaining anti-inflation credibility in the Warsh era. In other words, while the war may ease, the underlying constraint of high yields may not automatically be lifted. Strategists and traders generally believe the recent surge in long-term US bond yields will not completely reverse with a fall in oil prices causing inflation to drop, as the rise in real yields accounts for most of the overall increase in US yields. Fiscal issues are the first main source of stickiness in long-term yield. The US is already burdened with high debts and interest payments, and with tariff rebates, tax reduction demands, military spending expansion, and rising debt service costs, fiscal deficits are expected to grow again; this means the Treasury will need to continue issuing more bonds, and long-term investors will demand higher term premiums to absorb the supply. The unprecedented AI investment boom is becoming a new variable for long-term bond yields. It may lower unit costs through productivity gains in the long term, while raising capital demand in the short to medium term: tech giants issuing corporate bonds, data center construction requiring electricity, land, equipment, semiconductors, and capital spending on AI investment leverage, interest rate swaps, and project financing will create "synthetic duration" supply. More importantly, the AI boom makes equity assets relatively more attractive, prompting bond investors to seek higher yields as compensation. Therefore, AI is not simply an "anti-inflation technology," it functions more like a capital spending black hole absorbing global savings and driving up equilibrium real interest rates. Global resonance in long-term bond yields will also limit the downward space for US bonds, especially as global long-term government bonds are demanding higher risk compensation based on term premiums. If the Japanese government continues to face inflation pressure and rising ultra-long-term bond yields, increasing the attractiveness of domestic assets, it may weaken the marginal drive to allocate US bonds abroad; if fiscal and political uncertainties increase in the UK, risk premiums for UK bonds may spill over to global long-duration assets. The US bond market is transitioning from a period of "temporary inflation shocks driven by geopolitical conflicts" to a new era of pricing "structural high yield curves driven by fiscal, AI, real yields, and neutral interest rate hikes." While peace agreements may alleviate risk premiums and oil price fluctuations, they won't automatically resolve the expansion of deficits, government bond supply, AI financing competition, and the reversal of global savings-investment balances. As an important risk-free rate anchor on the denominator of the DCF valuation model, the 10-year US Treasury bond yield, if sustained at high levels, will make fluctuations in the valuations of risk assets such as stocks more pronounced. When the 10-year US Treasury bond yield rises, capital costs increase, the present value of future cash flows decreases, especially putting pressure on high-valuation technology growth stocks, small-cap stocks, real estate, consumer stocks, and highly leveraged assets. More precisely, this does not simply mean "high yields = stock decline,", but instead implies that risk assets are entering a higher volatility, higher differentiation pricing environment, meaning the "valuation expansion bull market" may make way for a "profit validation bull market," with severe fluctuations and sector differentiation likely becoming the norm. If corporate profitability remains strong, such as AI leaders consistently realizing profits, stock prices may still rise; however, the margin for error in valuations will decrease, and any disruptions in profit expectations, AI capital returns, oil prices, or fiscal deficits may lead to a rapid repricing in the market through higher discount rates and higher risk premiums. A recent Morgan Stanley strategy team said that while the overall US market is still supported by AI and strong profits, with high breadth, high momentum, high valuation technology stocks will be more sensitive to bond sell-offs. Risk assets that can truly withstand high yields must have high free cash flow, pricing power, low leverage, strong real profit growth paths/productivity realization logic.