AI's Biggest Bull Market Enemy Isn't a Bubble, But the Bond Market?
- Core Thesis: Bank of America's Chief Strategist warns that surging US Treasury yields and tightening financial conditions have surpassed corporate earnings as the core market risk; this could lead the Fed to raise rates, triggering deleveraging in tech stocks and AI-related assets. Meanwhile, the credit risk of hyperscale cloud service providers has hit a record high, questioning the return logic of AI capital expenditures.
- Key Elements:
- The 30-year US Treasury yield has risen to 5.2% (highest since June 2007), with real yields reaching 3% (highest since November 2008). US technology bond prices have fallen to two-year lows, and tightening financial conditions have become the market's primary concern.
- Credit default swaps (CDS) for hyperscale cloud service providers have surged to all-time highs, with bondholders questioning the return on AI capital expenditure. Despite solid earnings reports from Google and Intel, chip stocks were still sold off.
- The report introduces an "FCI > EPS" framework, arguing that the impact of financial conditions on the market has surpassed the support from corporate earnings. The implied probability of a Fed rate hike in July is 38%, and such a move could reverse the bull market logic for equities.
- "Blue-collar semiconductor" stocks (like Texas Instruments) have fallen 21% from their June highs, indicating a weakening leading indicator for the industrial cycle. Hyperscale tech giants are struggling to hold support at their 200-day moving averages.
- On a macro level, supply has become the core driver of the 2020s, including constraints on labor, imports, and oil supply. Meanwhile, the supply of bonds and equities is increasing, exerting pressure on capital.
- Gold and Bitcoin are quietly bottoming out in 2026; the bank stock index is expected to outperform brokerage and private equity indices in the latter half of the 2020s.
Original Author: Dong Jing
Original Source: Wall Street Insights
The bond market is becoming the most dangerous variable in the AI bull market.
On July 27, Bank of America Chief Investment Strategist Michael Hartnett issued a warning in the latest Flow Show report: The 30-year US Treasury yield has risen to 5.2%, the highest level since June 2007, real yields have hit a peak of 3%, the highest since November 2008, and US technology bond prices have fallen to two-year lows—the tightening of financial conditions is surpassing corporate earnings as a support for the market.
Hartnett's core assessment is: Pressure in the bond market won't dissipate on its own; instead, it may force the Fed to raise interest rates, which is precisely the outcome the stock market fears most. He warns that if the bull-market combination of "rising bond yields and rising bank stocks" flips to "higher yields, lower bank stocks,"it could become the trigger for a new wave of deleveraging in risk assets.
Meanwhile, credit default swaps (CDS) for hyperscale cloud computing companies have surged to all-time highs, as bondholders are voting with their feet, questioning the return logic of AI capital expenditure frenzy.
The backdrop to this warning is that chip stocks were sold off even after Google and Intel reported solid earnings, with the market's real concern shifting from 'can they make money?' to 'who will foot the bill?'—if the bond market no longer funds the AI bonanza, where will the money come from for those sky-high memory chips and cutting-edge models with negative returns?
Bond Market Pressure Outweighs Earnings, Financial Conditions Become the Core Variable
In his report, Hartnett explicitly introduced the core framework "FCI > EPS," meaning that the impact of tightening financial conditions (Financial Conditions Index) on the market has surpassed the supportive role of corporate earnings (EPS).
The 30-year US Treasury nominal yield has reached 5.2%, the highest since June 2007; real yields have risen to 3%, the highest since November 2008; US technology bond prices have fallen to two-year lows. The convergence of these three indicators means that financing costs in the market are systematically rising, a pressure yet to be fully priced in by stock investors.
Hartnett noted that globally, there have been 23 central bank rate hikes so far in 2026, and Bank of America expects another 18 before year-end. More notably, the implied probability of a rate hike at the Fed's July 29 meeting has risen to 38%, while the September 16 meeting has fully priced in one hike. He even posed a provocative judgment in the report:
"Politically, it would be smarter for the Fed to raise rates this week than to wait until September, wouldn't it?"
Hartnett's logical chain points to a paradoxical outcome: The pressure in the bond market may actually force the Fed to raise interest rates to stabilize long-term yields. He believes this situation can only be resolved through Fed rate hikes to curb disorderly upward movement in long-end yields.
However, rate hikes are not good news for the stock market. Hartnett warns, It is crucial to monitor whether the bull-market combination of 'rising yields, rising bank stocks' flips to 'higher yields, lower bank stocks'—such a flip would trigger deleveraging in risk assets. In this scenario, he views going long on the US dollar as the best hedge against the Fed's hawkish stance.
He also pointed out that stock investors currently do not see interest rates as a threat to the "Anything But Bonds" bull market. However, if a market-friendly Trump administration tolerates rate hikes to "put the brakes" on the stock market and anti-billionaire sentiment, the market would face a significant negative shock.
Hyperscaler Credit Risk at Record Highs, AI Capital Expenditure Logic Questioned
The most direct manifestation of bond market pressure is the sharp deterioration in credit risk indicators for hyperscale cloud computing firms. According to the report, credit spreads for this group have widened significantly, with CDS reaching all-time highs and the magnitude of bond issuance concessions also expanding.
The root cause of this phenomenon is market skepticism about the return on investment (ROI) for AI capital expenditures. Google and Tesla are seen as benchmarks for capital expenditure ROI. Despite solid earnings reports last week from Google and Intel, chip stocks were still sold off. The core question the market is asking:
If bondholders are no longer willing to fund the AI feast, cutting-edge models and memory chip demand that rely heavily on continuous capital investment could face a funding shortfall.
Hartnett's views resonate with Goldman Sachs' top derivatives trader Brian Garrett, who previously warned that the real risk for AI stocks lies not within the stock market but in the bond market. Garrett had warned for two consecutive weeks that credit market pain would intensify, noting that the S&P 500 is increasingly less representative of the average stock's performance, with internal divergence (low correlation, high dispersion) intensifying.
Additionally, Hartnett views "blue-collar semiconductors"—including Texas Instruments, Analog Devices, NXP, Microchip, ON Semiconductor, STMicroelectronics, Infineon, and Monolithic Power—as leading indicators for the industrial cycle. This group has fallen 21% from its June high.
Meanwhile, the hyperscale tech giants (MAGS) are struggling to hold the 200-day moving average (65 USD) support level, challenging the widely held market consensus of a "boom." The Bank of America July fund manager survey showed investor overweighting in industrial stocks at its highest since July 2021.
In response to these signals, Hartnett's short-term trading advice is: Go long on defensive stocks, high-dividend stocks, and long-duration bonds; go short on bank stocks (which have seen significant recent inflows), brokerages, tech stocks, and industrial stocks, to position for a reversal of the 'boom' narrative.
Dual Pressure from Bond and Stock Supply, Gold and Bitcoin Quietly Bottoming Out
From a broader macro perspective, Hartnett characterizes the 2020s as: An era of rising political populism, globalization giving way to national security, fiscal excess shifting to AI capital expenditure excess, the Fed's independence bending to political pressure, and American exceptionalism evolving towards global rebalancing.
Against this backdrop, "supply" rather than "demand" has become the primary macro and market driver. This is reflected in three key areas:
Immigration controls compress labor supply (US initial jobless claims fell to their lowest since 1969); protectionism and tariffs restrict import supply (the US is proposing new tariffs on 60 trading partners); geopolitical tensions disrupt oil supply (of the global ~80 billion barrels/day of seaborne oil, ~64 billion barrels pass through chokepoints like the Strait of Hormuz and Bab el-Mandeb).
In contrast, constraints on bond and stock supply are loosening. The US government maintains an annual fiscal deficit of $2 trillion, with annual interest payments reaching $1 trillion, a gap not closed even by $250 billion in tariff revenue over the past 12 months. Companies with negative free cash flow are reducing share buybacks, further diminishing stock supply support.
In this context, Hartnett believes gold and Bitcoin are quietly bottoming out in 2026, while the bank stock index, representing "Main Street," will outperform the brokerage and private equity indices representing "Wall Street" in the latter half of the 2020s.
Furthermore, he ranks Hong Kong real estate stocks among the most attractive long-term buying opportunities—trading at levels last seen 30 years ago. He states he will buy the dips during any sell-off triggered by Fed tightening or a crisis related to the Bank of Japan's exchange rate policy.
