Soaring US Long-Term Bond Yields Highlight Need for Stock and Bond Investment Strategy Revamp

The recent phenomenon of simultaneous declines in stocks and bonds has deepened investors' concerns. In the past, when the stock market was unstable, bonds acted as a safe haven, offsetting losses. However, in a rising interest rate environment, bonds' status as a safe asset is weakening. For example, investors who suffered a 30% loss in stocks and a 1% loss in government bonds are in a difficult situation to decide which asset to sell first.

The upward trend in long-term bond yields continues, with the US 30-year Treasury yield surpassing 5.2% and the 10-year yield exceeding 4.5%. This indicates a surge in demand for the US government to borrow money. Even though the government is implementing buyback measures to repurchase government bonds, yields continue to rise due to the immense market borrowing demand and persistent inflation concerns. Ultimately, a large number of borrowers will inevitably act as upward pressure on interest rates.

The US national debt has surpassed $40 trillion, facing serious structural risks. Interest burdens are rapidly increasing in the process of refinancing maturing debt. As debt previously raised at low interest rates is refinanced in a high-interest environment, the amount of interest the government has to pay increases, and the overall debt size grows exponentially. This is a major factor amplifying concerns about national fiscal soundness.

Governments generally prefer to issue bonds with longer maturities. This is because issuing long-term bonds can fix future interest costs and reduce short-term fiscal pressure. However, the market is currently expressing concern about this government preference. The perception is spreading that increasing long-term bond issuance will exacerbate interest rate hike pressure, leading to market participants' doubts about the government's creditworthiness.

There are criticisms that the US government's shift in strategy to focus on short-term bond issuance instead of long-term bonds is deepening a 'card rolling' style debt repayment structure. While an increase in short-term bond issuance can initially avoid temporary interest rate hike pressure, in the long run, it increases the burden of repeatedly repaying more short-term debt. This rather amplifies market anxiety, and the government's request to moderate the pace of interest rate hikes, coupled with the Fed's hawkish minutes, exacerbates policy uncertainty.

The Federal Reserve (Fed) is currently in a difficult dilemma. Market interest rates are soaring regardless of whether the benchmark rate is raised or not. Among the variables the Fed needs to control are economic pace and inflation, but currently, it is 100% focused on inflation control. However, as this policy exacerbates market burden and shakes policy credibility, the Fed is said to be in an awkward situation, unable to move forward or backward.

It is projected that the government, not the Fed, will drive the direction of interest rates in the future. Analysis suggests that the Fed's influence will gradually diminish, and national debt and the proportion of bond issuance will have a greater impact on interest rate direction. Investors will increasingly need to continuously monitor the proportion of long-term bonds in the bond issuance plans announced quarterly. This also suggests the possibility of the Fed transitioning into a 'mini-Fed'.

One of the most useful indicators for gauging market concerns is the US 30-year Treasury yield. It is easy to check daily and reflects the market's long-term expectations and anxieties. In particular, observing the spread between the 30-year and 10-year yields can help ascertain how much the market is concerned about fiscal health or whether long-term inflation anxiety is easing. An expanding spread indicates deepening concerns about fiscal health and long-term inflation anxiety.

There is a possibility that next year's consumer price inflation rate will be lower than this year's, falling below 3%. This is due to a reverse base effect from international oil prices; if the average international oil price next year is lower than this year, the oil price burden on inflation may decrease, making consumer price inflation appear lower. Particularly, if international oil prices remain below $80, there is a high probability that the market's key focus will shift from fiscal soundness back to inflation. The $80 international oil price mark will be an important turning point for the inflation outlook.

To assess the actual state of the US labor market, attention should be paid to the 4-week average of initial jobless claims. Even if overall employment indicators weaken, if the 4-week average of jobless claims does not significantly increase, it can be interpreted to mean that while employment decreased, there were no large-scale layoffs. It is only when the 4-week average enters a period of sustained increase from around 200,000 cases that it truly acts as a real shock factor for the economy, which will also affect the Fed's priorities in determining the benchmark interest rate.

The core of the burden of rising ultra-long-term bond yields is connected to the Japanese Yen. Japan appears to be cooperating with US interest rate stability by not selling US Treasuries to curb the yen's depreciation. However, if the yen's value significantly weakens, such as surpassing 160 yen, it could act as a supply-and-demand-driven factor for rising US Treasury yields, separate from fiscal soundness. Yen weakness increases the likelihood of Japan selling additional US Treasuries, which could further push up US interest rates. In this regard, the discrepancy between expectations for the Fed's rate hike cycle to end and the hawkish stance of other major central banks is affecting US Treasury yield volatility. For example, the Reserve Bank of Australia unexpectedly raised rates, and the European Central Bank maintained a hawkish stance, weakening expectations for Fed rate cuts. Particularly, recent concerns have been raised that China's decreasing foreign exchange reserves could lead to US Treasury sales. This could exacerbate supply-demand imbalances in the US Treasury market, adding to upward pressure on interest rates.

In the current high-interest rate environment, it is necessary to shift the perspective from capital gains to opportunities for generating stable cash flow. Compared to the first half of last year, when the 10-year government bond yield was 2.5%, it has now risen to 4.2%, creating various options to secure high cash flow through promised interest income. Bond products that provide stable interest income, such as US Treasuries or Brazilian bonds, are emerging as attractive investment targets.

In the current volatile market, a differentiated strategy for stocks and bonds is necessary. For stocks, profit should be pursued through rotational buying, while bonds should be approached by utilizing higher interest rates to create stable cash flow. Bonds with a fixed maturity can effectively offset market volatility by providing predetermined interest despite interest rate fluctuations. This strategy is also a common direction seen in the consulting results for high-net-worth individuals.

Higher interest rates imply a higher required rate of return on capital. Generally, when interest rates rise, dividend yields tend to rise concurrently. Therefore, in the current high-interest rate environment, rebalancing to a dividend-focused stock portfolio can help leverage the current trend. Dividend stock investment is emerging as an alternative that can reduce the risk of stock price volatility while expecting stable returns.

The current rise in interest rates is primarily due to factors related to the cost of capital, specifically the term premium reflected in the US 10-year Treasury yield or the rise in real interest rates. These indicators are currently in the red zone and are driving the interest rate increase. However, if signals indicating an economic slowdown, such as tightening bank lending standards or widening corporate bond spreads, begin to appear, the market's key focus is likely to shift from interest rates to the economy. If such a change becomes visible, opportunities for capital gains in bonds may arise.

The recent sharp drop in Walmart's sales can be interpreted as a sign of slowing consumption, but there are variables that differ from the traditional linkage where a consumption slowdown simply leads to growth slowdown and interest rate cuts. Analysis suggests that the primary reason for Walmart's sales decline is not consumers' intention to reduce spending, but rather a decrease in purchasing power due to high inflation. In other words, the high perceived inflation in the US is causing a contraction in consumption, which suggests that the Fed is likely to prioritize addressing inflation over economic shocks.