Original Author: Dong Jing
Original Source: Wall Street Insights
The bond market is becoming the most dangerous variable for the AI bull market.
On July 27th, Michael Hartnett, Chief Investment Strategist at Bank of America, issued a warning in the latest Flow Show report: The 30-year U.S. Treasury yield has risen to 5.2%, its highest level since June 2007, real yields have hit a peak of 3% since November 2008, and U.S. tech bond prices have fallen to a two-year low—the degree of tightening in financial conditions is now surpassing corporate earnings' ability to support the market.
Hartnett's core judgment is: Pressure in the bond market will not dissipate on its own; instead, it may force the Fed to raise interest rates, and rate hikes are precisely the outcome the stock market least wants to see. He warns that once the bull market combination of "rising bond yields, rising bank stocks" flips to "the higher the yields, the more bank stocks fall," it could become the trigger for a new round of deleveraging in risk assets.
Meanwhile, the credit default swaps (CDS) for hyperscale cloud computing companies have reached historical highs, indicating that bondholders are voting with their feet, questioning the return logic of the AI capital spending frenzy.
The backdrop to this warning is: Chip stocks were sold off even after Google and Intel reported solid earnings, showing the market's real worry has shifted from "can it make money?" to "who will pay for it?"—if the bond market stops funding the AI feast, where will the money come from for those exorbitantly priced memory chips and frontier models with negative returns?
Bond Market Pressure Exceeds Earnings, Financial Conditions Become the Core Variable
In the report, Hartnett explicitly proposes the core framework "FCI > EPS," meaning the tightening of financial conditions (Financial Conditions Index) is now impacting the market more than the support from corporate earnings (EPS).
The 30-year U.S. Treasury nominal yield reaching 5.2% is the highest since June 2007; real yields rising to 3% are the highest since November 2008; U.S. tech bond prices hitting a two-year low. The combination of these three indicators implies a systematic increase in market financing costs, and this pressure has not yet been fully priced in by equity investors.
Hartnett points out that there have been 23 central bank rate hikes globally so far in 2026, and Bank of America expects 18 more by year-end. More notably, the implied probability of a Fed rate hike at the July 29th meeting has risen to 38%, while a hike is fully priced in for the September 16th meeting. He even throws out a provocative judgment in the report:
"Politically, wouldn't it be smarter for the Fed to hike this week than to wait until September?"
Hartnett's logic chain points to a paradoxical outcome: Pressure in the bond market might instead force the Fed to raise rates to stabilize long-term yields. He believes resolving this situation can only rely on the Fed hiking rates to suppress the disorderly rise in long-end yields.
However, rate hikes are not good news for stocks. Hartnett warns, It is crucial to closely monitor whether the bull market combination of "rising yields, rising bank stocks" flips to "the higher the yields, the more bank stocks fall"—a flip would become the trigger for risk asset deleveraging. Under this scenario, he views going long the U.S. dollar as the best hedge against a hawkish Fed stance.
He also notes that equity investors currently do not see interest rate levels as a threat to the "Anything But Bonds" (ABB) bull market, but if a pro-market Trump administration tolerates rate hikes to "put the brakes on" the stock market and anti-billionaire sentiment, the market would face significant negative impact.
Hyperscaler Credit Risk Hits Record Highs, AI Capital Spending Logic Questioned
The most direct manifestation of bond market pressure is the sharp deterioration in credit risk indicators for hyperscale cloud computing companies. According to the report, credit spreads for this group have widened significantly, CDS have reached all-time highs, and concessions in bond issuance are also continuously expanding.
The root cause of this phenomenon lies in market skepticism about the return on investment (ROI) of AI capital expenditures. Google and Tesla are seen as benchmark companies for "return on capital expenditure," but despite Google and Intel's solid earnings last week, chip stocks were still sold off. The core question the market raises is:
If bondholders are no longer willing to foot the bill for the AI feast, where will the funding come for frontier models and memory chip demand that are highly dependent on continuous capital investment, risking a funding breakdown?
Hartnett's view previously resonated with that of Goldman Sachs' top derivatives trader, Brian Garrett—the real risk for AI stocks is not within the stock market itself, but in the bond market. Garrett had already warned for two consecutive weeks that pain in the credit market would intensify, pointing out that the S&P 500 index is increasingly failing to represent the performance of the average stock, with market internal divergence (low correlation, high dispersion) intensifying.
Additionally, Hartnett identifies "blue-chip semiconductors"—namely Texas Instruments, Analog Devices, NXP, Microchip, ON Semiconductor, STMicroelectronics, Infineon, Monolithic Power Systems—as leading indicators for the industrial cycle. This basket has fallen 21% cumulatively since its June peak.
Meanwhile, mega-cap tech giants (MAGS) are struggling to hold support at the 200-day moving average (around $65), challenging the broadly held "prosperity" consensus. Bank of America's July fund manager survey shows investor overweights in industrial stocks are at their highest since July 2021.
In response to these signals, Hartnett's short-term trading recommendation is: Go long defensive stocks, high-dividend stocks, and long-duration bonds; go short bank stocks (which have seen heavy recent inflows), broker stocks, tech stocks, and industrial stocks to hedge against a reversal of the "prosperity" expectation.
Dual Pressure from Bond and Equity Supply, Gold and Bitcoin Quietly Bottoming
From a more macro perspective, Hartnett characterizes the 2020s as an era of: rising political populism, globalization giving way to national security, fiscal excess shifting to AI capital expenditure excess, Fed independence compromising with politics, and American exceptionalism evolving toward global rebalancing.
In this context, "supply" rather than "demand" becomes the primary driver of macro and markets. This is reflected in three layers:
Immigration control compresses labor supply (U.S. initial jobless claims drop to lowest since 1969); protectionism and tariffs restrict import supply (U.S. plans new tariffs on 60 trading partners); geopolitics disrupts oil supply (of ~80 million barrels/day of global seaborne oil, ~64 million pass through vulnerable chokepoints like the Strait of Hormuz, Bab el-Mandeb).
In contrast, constraints on bond supply and equity supply are loosening. The U.S. government maintains an annual fiscal deficit of $2 trillion, with annual interest payments of $1 trillion, a gap not easily filled even by $250 billion in tariff revenue over the past 12 months. Companies with negative free cash flow reducing stock buybacks further diminishes a key support for equity supply.
Against this backdrop, Hartnett believes gold and Bitcoin are quietly bottoming in 2026, while bank stock indices representing "Main Street" will outperform broker and private equity indices representing "Wall Street" in the second half of the 2020s.
Furthermore, he lists Hong Kong property stocks as one of the most attractive long-term buying opportunities—these stocks are currently priced at levels seen 30 years ago, and he states he would buy the dip on any declines triggered by Fed tightening or a Bank of Japan currency crisis.
