Thanks to surging yields, investors are getting their best return on capital in the bond market since 2002.
The 10-year Treasury yields 5.2% this morning.
At those rates, investors can earn a respectable return without having to guess which AI stock will justify its valuation, which hyperscaler will earn a return on its data centers, or which CEO will discover that borrowing hundreds of billions of dollars requires repayment first.
And for the first time in decades, the attraction goes beyond income. Yields will eventually peak. When they turn lower, bond prices will rise. Long-duration bonds will rise fastest.
That puts the iShares 20+ Year Treasury Bond ETF (TLT) in an interesting position.
TLT owns long-dated Treasury bonds, which makes it particularly sensitive to changes in interest rates. A sharp decline in long-term yields could produce a double-digit move higher in the ETF price.
Options traders – or one big player – appear to be positioning for exactly that possibility. Call activity in TLT has surged:
Options on TLT will double or better from a sudden drop in long-term yields.
Options traders appear to be positioning for exactly that possibility. Call activity in TLT has surged. Someone is putting real money behind a forecast that long-term yields will fall soon and fall hard.
There are several possible catalysts for a wicked fall in long-term yields.
Scott Bessent wants lower borrowing costs. We covered the “Treasury Twist” he’d trying engineer on September 15. A recession would likely do much of the work for him. During a recession, investors would buy Treasurys for higher yields, Kevin Warsh would have reason to cut rates, and bond prices would rise.
Investors who simply own the bonds are getting paid more than 5% while they wait for a recession to do its dirty work.
That creates an opportunity we haven’t seen in years. When Treasury yields hovered around 1% or 2%, bond investors collected crumbs while waiting for rates to fall. At 5% or better, the meter is running in their favor.
There is risk. Inflation could remain stubborn. Treasury officials still have enormous quantities of debt to finance. Bond buyers could demand still higher yields. TLT has a long duration, so another surge in rates would hit its price hard.
That sensitivity is exactly what creates the trade.
If yields remain near current levels, Treasury investors will continue to collect substantial income. If recession, falling inflation or easier Fed policy pulls yields lower, long-duration bonds add capital gains to the income.
There’s one more twist at 5% Treasurys create another problem for the stock market.
Investors can now ask Larry Ellison, Mark Zuckerberg, Satya Nadella and the rest of the AI crowd a question they barely had to answer when money was cheap: Why should I finance your next data center when Scott Bessent will pay me 5% to lend money to the United States?
Every corporate borrower has to answer that question with a higher return. Oracle has to pay more for debt. Data-center developers have to offer lenders better terms. Stock investors must demand sufficient earnings growth to justify taking on equity risk.
The higher Treasury yields climb, the higher that hurdle gets.
As if on cue, a piece in Startup Fortune this morning shows JPMorgan, Morgan Stanley, and a few other Wall Street’s biggest banks “are quietly shopping pieces of the AI debt pile they helped build, a sign the lenders closest to the money have started hedging their own bet.”
We expect the bond market to tell us when the cycle turn begins in earnest. Watch long yields, TLT, credit spreads and the cost of financing the AI buildout. As we’ve been forecasting for some time now, the bond market is likely the future epicenter of the breakdown in AI financing.
For the first time in nearly two decades, investors can collect high income while they wait for the drama to unfold. Andrew’s Pro recommendation today adds an interesting twist.
~ Addison
P.S. Last week, Grey Swan Live! returned with John Robb.
We continued the conversation that John started in recent issues of the Grey Swan Bulletin.
Specifically, we reviewed John’s thesis that the age of “mass” – dominated by large nation-states and large corporations – is giving way to a new geopolitical order.
- Mass media has already fractured into millions of competing voices.
- Politics no longer produces anything resembling national consensus.
- AI is beginning to dismantle the mass market.
- And cheap drones and robotics are changing warfare so dramatically that relatively small countries can increasingly frustrate much larger military powers.
John argues these aren’t separate stories.
They’re manifestations of the same technological shift.
The replay is up on the site for members. Make sure you take advantage of this feature of membership – we love being able to share our conversations with some of the smartest minds today in Grey Swan Live!
We’re traveling this week, but expect to have Grey Swan Live! this week at the usual time. More details on the guest and topic to come.
