Morgan Stanley: Bond Market Already Priced In Fed Hikes, US Stocks Watch Two Signals for Rebound

Bond Market’s Unofficial Rate Hikes May Signal Peak for Fed’s Tightening

The yield on 10-year U.S. Treasury bonds has surged 120 basis points since February, leading to a significant tightening of financial conditions. Morgan Stanley strategist Mike Wilson suggests the bond market has already completed the Federal Reserve’s rate-hiking work. If this week’s Consumer Price Index (CPI) data comes in moderate, the worst for U.S. equities may be over, but the key to any rebound hinges on two signals: the MOVE index and financial sector earnings.

Bond Market’s Unofficial Rate Hikes May Signal Peak for Fed’s Tightening

While the Federal Reserve has yet to act, the bond market has quietly enacted its own rate hikes. According to a report by Wallstreet News, Morgan Stanley’s Chief U.S. Equity Strategist Mike Wilson, in his latest weekly note, dissected a rare market dynamic: the 10-year U.S. Treasury yield has climbed 120 basis points since February. This, coupled with a strengthening dollar and elevated oil prices, has collectively resulted in a substantial tightening of financial conditions, significantly easing pressure on the Fed to further raise its policy rate.

In his “Weekly Warm-up” report released Monday, Wilson pointed out that the confluence of multiple factors has already led to monetary tightening effects rippling through the market. The 120-basis-point jump in 10-year Treasury yields since February, a stronger dollar index, and sustained high oil prices have together created a tangible tightening of financial conditions.

Global government bond yields have now collectively surpassed 4%, a level not seen since 2000. Wilson believes that with the bond market already pricing in significantly higher interest rates, the policy pressure on Federal Reserve Chairman Kevin Warsh is effectively reduced. If this week’s CPI data does not show an unexpectedly sharp increase, the upward momentum in long-term yields may begin to plateau.

Wilson noted that the S&P 500 has not fully reflected the current tightening of financial conditions because the index’s gains have been highly concentrated in a few large technology stocks centered around AI. These companies’ growth prospects are robust enough to withstand the impact of rising capital costs.

This structural divergence is already evident in market breadth. The S&P 500 Equal Weight Index has lagged the market-cap-weighted index by 6 percentage points since March, indicating that more common stocks are bearing the brunt of the pressure from rising long-term rates. Wilson emphasized that for the majority of individual stocks, the rapid rise in yields has already inflicted tangible damage.

Key Indicators for Market Pressure

Wilson advises investors to closely monitor two key indicators to determine if market pressure has peaked.

The first is the MOVE index, a measure of bond market volatility. Wilson believes that what truly matters is not the absolute level of yields, but the speed of yield changes and their volatility. A decline in the MOVE index would be a significant signal of easing pressure in the bond market.

The second is the relative performance of financial stocks. This week marks a concentrated period for third-quarter earnings reports from major banks including JPMorgan, Goldman Sachs, Citi, and Wells Fargo. Wilson suggests that if these banks report solid earnings, it would largely serve as a “clear the decks” signal.

While Wilson acknowledges the risk that persistently rising yields could evolve into a drag on growth, he currently believes this scenario has not yet materialized. He pointed out that the current yield increase is largely driven by capital demand stemming from economic growth itself, rather than solely by inflation or policy expectations.

From a real interest rate perspective, Wilson subtracted the current year-over-year CPI of approximately 3.4% from the effective federal funds rate of 3.88%. The resulting spread is significantly lower than the peak levels seen before past recessions, indicating that market pessimism regarding growth prospects is overestimated. Combined with optimistic expectations for the upcoming earnings season, Wilson concludes that U.S. equities still have room for improvement.