According to Woofun AI, the dramatic volatility in the bond market is quietly undertaking the Fed's tightening role, introducing a rare new framework for interpreting the direction of the stock market. Morgan Stanley (MS.US) Chief Equity Strategist Mike Wilson pointed out in his latest weekly report that as the U.S. 10-year Treasury yield has risen by a cumulative 120 basis points since February, financial conditions have tightened sharply, and the bond market is effectively replacing the Fed in carrying out interest rate hikes, which may allow the Fed to avoid further raising policy rates. Wilson believes that if the U.S. Consumer Price Index (CPI) data released this Wednesday is moderate, it will help ease pressure on long-term yields and market expectations for policy rates.
Against this backdrop, Wilson provided investors with two forward-looking signals: the relative performance of financial stocks and the MOVE Index, which measures bond market volatility. He emphasized that changes in bond market volatility are more indicative than the absolute level of yields, and this week, the Q3 earnings reports from JPMorgan (JPM.US), Goldman Sachs (GS.US), Citi (C.US), and Wells Fargo (WFC.US) will serve as key observation windows. The tightening effect in the bond market has already become evident. In Monday’s "Weekly Warm-up" report, Wilson noted that multiple overlapping factors are amplifying the tightening effect in the market: the 10-year Treasury yield has surged 120 basis points since February, the Dollar Index (DXY) has strengthened, and oil prices remain high. Together, these three factors have substantially tightened financial conditions. Global government bond yields have now collectively surpassed 4% for the first time since 2000.
Woofun AI’s compiled data shows that with the bond market already pricing in much higher rates, Fed Chair Jerome Powell is actually facing less policy pressure. If this week’s CPI data does not significantly exceed expectations, the momentum driving long-term yields higher may begin to slow.
S&P 500 gains mask internal divergence. Wilson pointed out that the S&P 500 Index has not fully reflected the current tightening of financial conditions because gains have been highly concentrated in a handful of mega-cap tech stocks focused on artificial intelligence—companies whose growth prospects are robust enough to offset the impact of rising capital costs.
This structural divergence has become conspicuous in terms of market breadth. Since March, the S&P 500 equal-weighted index has lagged the market-cap-weighted index by as much as 6 percentage points, indicating that ordinary stocks have already been under greater pressure from rising long-term yields. Wilson emphasized that for most stocks, this rapid yield rise has caused substantial damage. Two signals will determine whether the worst is over. Wilson advises investors to closely monitor two indicators to determine whether market pressures have peaked. The first is the MOVE Index, the bond market volatility index. Wilson believes the key is not the absolute yield level, but the rate of change and volatility of yields. A decline in the MOVE Index will be an important signal that bond market pressure is easing. The second is the relative performance of financial stocks. With Q3 earnings for JPMorgan, Goldman Sachs, Citi, and Wells Fargo being released this week, Wilson believes that strong earnings from these banks would, to a large extent, send the signal to "fully lift the alarm."
Recession concerns may be overestimated. Although Wilson acknowledges that persistently rising yields carry a risk of becoming a drag on growth, he currently does not see this materializing. He notes that the current rise in yields is largely driven by economic growth itself and the capital demand it spurs, rather than solely by inflation or policy expectations. From a real interest rate perspective, Wilson subtracts the current year-on-year CPI of about 3.4% from the effective federal funds rate of 3.88%, resulting in a spread far below peaks seen before previous recessions. This suggests that market pessimism regarding growth prospects may be overdone. Combined with optimistic expectations for the upcoming earnings season, Wilson concludes that there is still room for improvement in U.S. stocks.