Will US debt crash the US stock market this time?

The continued rise in U.S. Treasury yields is pushing financial markets to a critical tipping point. Bloomberg macro strategist Simon White warns that as yield increases become increasingly erratic and term premiums widen, the nature of bond market volatility is subtly changing. Meanwhile, market observers point out that if long-term interest rates continue to rise, the current stock market valuation system, built on low financing costs, will face increasing pressure.

The trigger for this round of bond market sell-off was the PMI data released in early September. After the data significantly exceeded expectations, US Treasury yields jumped more than 10 basis points in a single day, and continued to rise by 2 to 3 basis points over the next two days. The 10-year Treasury yield once touched 5.14%, the highest level since 2007; the 30-year yield rose to about 5.4%, and the 2-year yield also climbed to about 4.9%. Since September alone, the 10-year yield has risen by approximately 35 basis points.

The rapid rise in yields is spreading to multiple markets, including stocks, credit, private equity, and consumer credit. Analysts point out that with US federal debt exceeding $40 trillion and margin leverage at historically high levels, continued pressure on the bond market could trigger a chain reaction through financing costs, asset valuations, and leveraged liquidations, with the potential impact exceeding what is currently reflected in market pricing.

The nature of the yield increase has changed, and the term premium has widened.

In his analysis, Simon White points out that the nature of this round of yield increases is undergoing a significant change. Previously, the rise in long-term yields was mainly driven by rising expectations of short-term interest rates, which was to some extent a "benign" yield increase, meaning that financial conditions were returning to a more normal level and also helped reduce the risk that the Federal Reserve and the Treasury would lose control of long-term interest rates.

However, the situation reversed after the PMI data was released. About half of the single-day increase in the 30-year yield came from a widening term premium. Simultaneously, bond market volatility rose significantly, and the yield curve steepened. These signals collectively indicate that the rise in yields is becoming more disorderly, and investors are beginning to demand higher risk compensation.

White points out that the reason why strong economic growth has actually increased the risk of US debt lies in the fact that this growth is largely based on fiscal spending that is not suitable for the current stage of the economic cycle. Since 2020, the US has accumulated a fiscal deficit of nearly $15 trillion, while the average unemployment rate during the same period was only 4.8%. In this process, large-scale fiscal spending has driven corporate profit growth and also provided important support for large-scale capital expenditures on AI infrastructure.

From a longer-term perspective, US Treasury yields have only recently returned to near their long-term averages, while historically, yields have often overshooted downwards. White warns that once the 10-year yield approaches the 5.25% to 5.50% range, the correlation between US Treasuries and stocks could turn positive. At that point, bonds would no longer be effective in hedging portfolios and could instead become a source of amplified portfolio losses.

The mathematical logic of bond market transmission to stock market

Market observer and author of QTR's Fringe Finance stated in his analysis that the transmission mechanism from the bond market to the stock market is "not complicated; it's just mathematics."

The logic is relatively clear: rising long-term interest rates mean that the discount rate used for stock valuation increases, and the present value of future earnings decreases accordingly; at the same time, corporate financing costs rise, private equity and private credit transactions are under pressure, highly leveraged companies face higher refinancing costs, consumer borrowing costs also rise, and the federal government's debt repayment pressure is further aggravated.

The U.S. Treasury market, exceeding $30 trillion, directly impacts mortgage rates, corporate bond financing costs, private equity financing conditions, and the price investors are willing to pay for every dollar of future earnings. While the stock market may ignore this transmission mechanism for a period, it is unlikely to deviate from it in the long run.

The analysis also cited data from the Federal Reserve showing that U.S. domestic non-financial debt reached approximately $84 trillion in the second quarter, including about $21.4 trillion in household debt, about $24 trillion in corporate debt, and about $38.7 trillion in government debt. Given this massive debt base, each step up in interest rates will have a more significant impact through interest payments and refinancing costs.

The risk of increased vulnerability due to both leverage and valuation

The current market vulnerability stems not only from interest rates themselves, but also from the highly leveraged structure built on low financing costs. According to FINRA data, margin debt reached approximately $1.45 trillion in August, up about 37% from a year ago, after hitting a record high of $1.50 trillion in June.

Leverage mechanisms tend to be self-reinforcing during an uptrend: rising stock prices increase the value of collateral, giving investors more access to financing and allowing them to borrow even more money to buy stocks. However, once the market reverses, this mechanism can also work in the opposite direction: falling stock prices reduce the value of collateral, increasing margin calls, and forced selling further depresses asset prices, ultimately creating stronger downward pressure.

Meanwhile, the financing structure of AI infrastructure has also attracted market attention. Related analyses indicate that a large amount of AI infrastructure investment is financed through debt, leasing, guarantees, and special purpose vehicles (SPVs), with some large technology companies placing some of their financing exposure off their balance sheets through guarantee arrangements. These analyses estimate that the off-balance-sheet obligations of the entire AI ecosystem could reach trillions of dollars. The bond market has already begun to react—reports indicate that credit default swap spreads for some hyperscale cloud computing companies have risen to historical highs.

US consumers' balance sheets are also under pressure. According to relevant data, US household debt is approximately $18.8 trillion, including about $1.26 trillion in credit card balances and about $1.71 trillion in auto loans. In the second quarter, about 7% of credit card balances were entering a state of serious delinquency at an annualized rate. Coupled with a higher interest rate environment, the debt repayment pressure on consumers may further increase.

Fiscal deficits and debt sustainability pose deep-seated concerns.

From a macro-fiscal perspective, the dynamics of U.S. debt are entering a more noteworthy cycle. The Congressional Budget Office (CBO) projects that the federal deficit will be approximately $1.9 trillion in fiscal year 2026, with publicly held federal debt accounting for approximately 101% of GDP. Net federal interest payments are projected to be approximately $1 trillion this year, and the CBO projects this will further rise to $2.1 trillion by 2036.

This means that the US government needs to continue borrowing, and rising interest payments further increase financing needs; at the same time, the refinancing cost of new debt remains constrained by the high-interest-rate environment.

The above analysis suggests that over the past 15 years, a deeply ingrained expectation has gradually formed in the market: whenever the economy or financial markets face significant downside risks, the Federal Reserve will ultimately intervene, returning to an environment of low interest rates, quantitative easing, and ample liquidity. However, this expectation is facing challenges—if high interest rates become the new normal rather than a temporary anomaly, the current asset pricing system, based on the assumption of low financing costs, will face greater pressure.

The analysis also points out that if the bond market ultimately evolves into a systemic crisis, policy responses may include yield curve control or other more forceful market interventions. However, before genuine policy support arrives, the market may still need to undergo significant adjustments.

Of course, there are still ways to mitigate the aforementioned risk scenarios. If inflation falls further and economic growth slows, long-term yields may experience a substantial pullback, which could alleviate current pressure on the bond market and provide renewed support for stock valuations. However, if yields continue to rise, and the market gradually redefines US Treasury yields above 5% as the "new normal," then the current market structure, built on low interest rates and high leverage, will face a more severe test.

Risk Warning and DisclaimerInvesting involves risk; please exercise caution. This article does not constitute personal investment advice and does not take into account the specific investment objectives, financial situation, or needs of individual users. Users should consider whether any opinions, views, or conclusions in this article are suitable for their specific circumstances. Any investment decisions made based on this information are at your own risk.