[Part 4] US interest rates soaring despite worsening employment data!? The future indicated by the divergence between the stock and bond markets

It was a little while ago, but…

“Even though US employment data fell below expectations, for some reason US Treasury yields jumped…”


“Stock investors are rejoicing and hitting record highs thinking ‘The rate hikes are over!’, while the bond market is screaming that ‘Supply and demand have collapsed.’”
This event, which split the opinions of investors on social media right down the middle and sparked a heated debate.
If you have read parts 1 through 3, you should understand just how bizarre and significant this phenomenon is.
In this final installment, based on actual posts, we will thoroughly dissect

the divergence between the ‘stock market perspective’ and the ‘bond market perspective’

and unravel future market scenarios using historical precedents!

1. The ‘divergence in market perspectives’ seen in two posts

The two posts that became a hot topic on social media are each looking at different markets.

Image

It is not that one of them is lying.
“The stock market, which is rejoicing in anticipation of the policy rate brakes being applied”
and
“The bond market, which is screaming at the mountain of piled-up government bond inventory”
—this intense divergence (distortion) was occurring simultaneously.

2. Why were government bonds sold off even though a “sign of economic deterioration” appeared?

As we learned in Part 2,
normally, when employment data worsens, government bonds should be bought due to ‘rate cut expectations’ or ‘flight to safety,’ causing yields to fall

. Despite this,

why were US Treasuries across all maturities dumped, causing yields to rise
?
The cause lies in the “poor supply and demand (balance between selling and buying)” that was strong enough to blow away all the bullish factors. ① Excess supply: The US government’s debt (increased issuance of government bonds) shows no signs of stopping

The US fiscal deficit continues to expand, and the Treasury Department is issuing astronomical amounts of new government bonds almost every week.
The market is overflowing with “government bonds put up for sale.”

② Lack of demand: Overseas buyers are decreasing

Overseas central banks and institutional investors, who have supported US Treasuries by buying them in large quantities until now, are slowing their pace of purchases.

③ Failure of flight-to-safety demand: Stocks were too strong

Because the unemployment rate remained at 4.2% and high-tech stocks hit record highs, the buying demand to “panic and flee to safe government bonds (flight to quality)” did not occur at all. No matter how much expectation there is that “the Fed is likely to cut rates,” the truth is that there were not enough buyers to take on the “excess inventory of government bonds,” leaving no choice but to sell them off (which equals rising yields).

3. It has happened before! The history of “rate cut expectations vs. rising interest rates”

The phenomenon where “government bond yields remain high or soar even though signs of economic deterioration are appearing” has appeared at major turning points in the market throughout history.

① 1994: “The Great Bond Massacre”

🔸Situation: Triggered by the Fed’s rate hikes, the market became wary of the “government’s increased debt burden,” leading to a global sell-off of government bonds.

🔸Outcome:
The 10-year Treasury yield soared from about 6% to nearly 8%, dealing a massive blow to bond managers.

② Summer 2007: The “distortion” on the eve of the subprime crisis

🔸Situation:
Expectations for Fed rate cuts emerged due to slowing employment. The stock market was optimistic, thinking “Rate cuts are coming!” and hit all-time highs.

🔸Outcome: Afterward, the distortions in the credit market and the pressure of interest rates could no longer be hidden, leading to the Lehman Shock (the great crash) in 2008.

③ Autumn 2023: The “term premium surge” shock
🔸Situation:
Due to concerns about the massive issuance of US Treasuries, the 10-year Treasury yield temporarily exceeded 5.0%, ignoring rate cut expectations.

🔸Outcome:
Unable to withstand the pressure of high interest rates, the US stock market plunged by about 10%. Interest rates finally calmed down after the US Treasury Department reviewed its bond issuance plan and suppressed the supply of long-term bonds.

4. What will happen to the market from here? 3 scenarios

When the stock market is excited, thinking “Happy days are here due to rate cut expectations,” and the bond market is wary, thinking “Interest rates are rising due to worsening supply and demand,” historically, the “harsh reality of the bond market” often catches up with the stock market in the end.
There are mainly three scenarios that can be considered from here.

1. Scenario A: Stock market adjustment (catching up later)

If long-term interest rates remain at a high level of over 5%, the cost of corporate borrowing and the burden of mortgage loans will increase, cooling the real economy.
This is a pattern where the stock market comes to its senses, thinking “Wait, aren’t the economy and interest rates in trouble?” and stock prices are forced to undergo a downward adjustment later.

2. Scenario B: Supply and demand measures by the government/central bank (continued stock price rise)

A pattern where the US Treasury Department takes measures to ease the supply and demand of government bonds, such as reducing the issuance of long-term government bonds and switching to short-term government bonds.
Interest rates calm down, and the stock market continues to perform well.

3. Scenario C: Full-scale recession (economic downturn)

A pattern where the deterioration of employment becomes serious, and corporate bankruptcies and mass layoffs become visibly more frequent.

It becomes impossible to talk about “rising stock prices due to rate cut expectations,” and a full-scale “flight to bonds (sharp drop in interest rates)” occurs amidst a general decline.

Summary of the 4-part series

✅Part 1:
When bond prices rise, yields fall (seesaw relationship)

✅Part 2:
Stocks rise on signs of economic downturn only when “rate cut expectations” win out

✅Part 3:
Policy rates (central bank) and long-term interest rates (market) are different things. Long-term interest rates directly hit daily life

✅Part 4:
Even if there are rate cut expectations, if the country’s debt (excess supply) is severe, long-term interest rates will not fall

When looking at daily economic news or social media posts, please try to be conscious of “which interest rate is the market looking at right now, and whose intentions are driving it?”
The “real psychological warfare of investors” behind the numbers should start to look completely different than it did before!