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Hello, I'm Aline Van Dyne in New York and welcome to the Macro Brief from HSBC Global Investment Research, a weekly podcast that looks at the key drivers of global financial markets.

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Today, we're discussing a topic that our clients are asking about a lot.

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high U.S. bond yields.

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U.S. Treasury yields are, of course, now well above 5%, the highest they've been for decades.

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What does it mean for the U.S. economy and what does it mean for global stock markets?

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I'm joined by Ryan Wang, our U.S. economist, and Alistair Pinder, our global equity strategist, to discuss these issues.

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So, Ryan, let's kick off with the fundamentals.

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What's going on in the U.S. economy that is pushing yields higher?

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I mean, it's a very interesting topic, and I think there's a wide variety of reasons.

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One, of course, is that the U.S. economy is showing some degree of resilience.

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So we can see that GDP growth this year, at least based on the available data, will likely grow by 2 percent on an inflation-adjusted basis at least.

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And at the same time, we've seen that inflation has remained quite elevated.

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So the Federal Reserve is and has begun to raise interest rates in an attempt to control inflation, to bring inflation lower.

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At the same time, we've seen very rapid demand for investment, particularly AI-related investment, and that is –

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Certainly a factor that has put upward pressure on interest rates.

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And that is coming at a time of large fiscal deficits in the United States.

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The fiscal year for 2026 has just ended.

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And we have just seen another close to $2 trillion U.S. annual budget deficit, 6% of annual GDP.

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And that has persisted for a few years.

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Doesn't look like that's about to change anytime soon.

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And Ryan, just on the hyperscalers, you mentioned AI.

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Hyperscalers have also been issuing a lot of debt, almost $250 billion this year.

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Is that another issue that's putting pressure on US bond deals, the competing nature between these corporates and the government at this point?

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Well, I think this is contentious.

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This is where I would probably want to turn it back to you.

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But, you know, at a fundamental level for economists, you know, when you have businesses and governments competing for the same amount of investable resources, then it's hard for us to say that it's not a factor.

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Of course, when you dig down at the markets, you can say, well, the investor bases are a little bit different.

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Right.

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So I think it's a it's a very interesting issue.

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And it's not so much about fears about fiscal issues and the like.

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So we've got some good news.

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We've got some bad news.

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Alistair, which part of this news cycle are equity markets responding to?

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What's driving the equity markets?

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I think there's a perception that given the resiliency of equity markets, I mean, the S&P 500 is still near all time highs, that there's complacency in the market.

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And I don't think that's true at all.

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I mean, actually, if you look at the valuations, we have seen pretty large compression.

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You know, the 12 month forward PE for the S&P 500 is down nearly 18 percent.

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Almost, you know, 30 to 40 percent of the S&P 500 constituents have derated by more than 20 percent at this point.

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This year?

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This year, yeah.

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And so it's a very large de-rating.

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And so I think people look at the headline S&P and think there's complacency, but the underneath that valuations has contracted.

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And why the S&P 500 has been resilient, it's not because of complacency, it's because the earnings growth

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which is running at, you know, 20, 30% year and year this year, has been more than able to outrun the compression valuations.

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So I think that's a really important point to make.

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And sorry to interrupt, but that's for the US specifically?

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That's for the US specifically.

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Or is that a global story?

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I mean, actually, I mean, the earnings growth globally has been very strong.

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I mean, in emerging markets, you had earnings growth in Q2 running around 60%.

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Again, that is actually driven predominantly by the AI narrative.

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But even stripping out tech, you had earnings growth of 25%.

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So I would say globally, there's definitely earnings growth going through.

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And that's been able to offset some of those headwinds from the valuations.

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I think the other thing that we would argue as well is that there's a belief in the market that there's this thing called the breaking point, that there must be a level of bond yields where equities break.

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I don't think that's true at all.

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I mean, actually, if you look across global equity markets, Brazil has bond yields at 14%.

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That market's rallying.

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It doesn't mean that just because bond yields are high, they have to break.

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But it's the speed of change that matters a lot.

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And I think what we've seen over the last few months where you have seen a very aggressive move higher in US 10-year bond yields, that has become a bit more concerning for the equity market.

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And underneath the hood, areas like small caps and other areas of the market which are a bit more sensitive have really struggled lately.

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So in some ways, just as Ryan started off describing these different drivers of the economy, some positive, some less positive, in the equity markets, is there a separation as well into kind of the good news stocks, the ones that are exposed perhaps to the extra AI spend, etc., and then the others?

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Or is there a separation emerging?

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I mean, I think the biggest separation for me is between the large cap and the small cap.

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So the large caps, which we can consider as the S&P 500, 80% of their debt is fixed.

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They have earnings growth running at 25%, 30% and debt is very low.

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So actually, higher interest rates really don't have that much of an impact on earnings.

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I mean, consider that every 100 basis point increase in the cost of debt.

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reduces their earnings by less than 1%.

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So not a huge impact.

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So not massively exposed to the higher yields.

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Completely.

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The Russell 2000, the small caps, is very different.

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Roughly 50% of their debt is floating.

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They are much higher leveraged.

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And roughly 40% of the Russell 2000 constituents have negative earnings.

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So there's a much higher impact from higher interest rates here.

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And the Russell 2000 is down around 10% since August.

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So again, you're starting to see the differentiation within the market of the areas that are sensitive to interest rates and the areas that are less sensitive.

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So sensitivity to interest rates.

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Ryan, when you look at the economy, what are the areas that are sensitive to the higher interest rates?

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I mean, the mortgage market, the housing market is what people often think of.

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What's your view?

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Yeah, I mean, it's a very interesting question.

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And just listening to Alistair talk about it, you know, we can talk about the Russell 2000 versus specific large cap companies.

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But then we can extend it even more broadly to the entire economy because the stock market is not the economy.

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The economy doesn't fully reflect publicly traded equity companies.

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And the Federal Reserve.

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is trying to basically manage the entire economy, in particular to bring inflation lower, right?

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So I think this is where this connection and this dissonance does make a difference.

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And to your point, Aline, I mean, the housing market is front and center.

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Mortgage rates well over 7%.

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We are close to, if not breaching, multi-decade highs.

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Certainly the 10-year U.S. Treasury yield at over 5% is essentially at multi-decade highs.

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Yeah.

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And these are metrics that really do have an impact on the economy.

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But how it breaks down at a very specific and granular level can be a little bit complicated.

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I think for the housing market in particular, we have seen and we know that the U.S. housing market, in a sense, is doubly exposed to higher interest rates because it weighs on housing demand.

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But at the same time, it can also weigh on housing inventory, housing supply, because we have fixed rate mortgages in

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Of course, anyone that has a mortgage at 3%, 4%, 5%, 6% is very reluctant to basically put that housing supply onto the market.

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It wasn't that long ago that interest rates were close to zero.

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So a lot of people presumably finance their mortgages at times when interest rates were at historically low levels.

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And so it becomes harder to exit because you're never going to get that level of cheap financing again.

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Yeah, and I think one way we see that is that house prices have remained remarkably firm in the face of multi-decade high interest rates, right?

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So house price appreciation over the past one, two years has not really turned negative on a national basis.

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And that's a big difference than what we saw, for example, leading up to the global financial crisis in 2007, 2008.

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I think one of the interesting things about, you know, the US market, though, is that the impact of higher mortgages and high interest rates on the consumer, I think, is a lot less than, say, in other areas of the world.

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I mean, one of the most interesting things that, you know, I realized when I moved to the US was that you get this thing called a 15 year, 20 year, 30 year fixed mortgage.

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I mean, like that is very rare in areas like the UK and 95 percent of mortgages in the US are fixed.

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Yeah.

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And in the UK and in Germany and in many areas of the world, including areas like Australia, a much, much higher proportion of those mortgages are floating.

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And so the US consumer may be a little bit more resilient to, you know, higher interest rates compared to other areas of the consumer, you know, elsewhere in the world at this point.

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Sure.

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But I suppose it may be the consumer may be more resilient to rates moving higher, but then the higher rates are also not fueling a boom in consumer spending.

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Although I think that is also an area that's been quite resilient.

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So just unpick that situation for us, Ryan.

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Sure.

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Well, I think it goes to what both you and Alistair have talked about.

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So, I mean, the Federal Reserve at its most essential level is trying to cool down U.S. economic momentum and higher interest rates are that mechanism.

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So if you are raising interest rates, the question is, where is that going to spill over differentially into different sectors of the economy?

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So, you know, I mean –

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If AI is booming right now, well, then I think most people think potentially that, well, that's not going to necessarily be curbed by a 25 basis point, 50 basis point increase in interest rates.

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Well, that kind of means from the Fed policymaker perspective that more of that burden will have to fall into the non-AI economy, which of course includes housing, right?

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The consumer, yes, it's true, has remained relatively resilient up to this point.

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I think there are wealth effects at play in the United States.

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We can see the booming stock market.

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We can see resilient house prices, which I just talked about.

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And that is a benefit for, of course, any holders of housing wealth or stock market wealth.

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But at the same time, you have a big proportion of the population that is struggling economically.

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that doesn't have as much of a wealth asset base to rely on and still with very elevated inflation is struggling.

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And the higher interest rates here are going to be a negative rather than a positive.

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So in one sense, that is the mechanism by which monetary policy is expected to act.

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But at the same time, it does create strains in the economy.

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And I think that K-shaped economy, which you're touching on, Ryan, is really important because when we look at the consumer stocks within the US, we see the evidence of that K-shape economy.

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economy coming through in the earnings.

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Also the corporate commentary where we often see, you know, the brands which are more skewed towards high income households doing slightly better than those that are more skewed towards the low to middle income households.

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And we're also seeing that in performance as well, where the companies that are those high income brands actually performing, you know, quite decently, despite this, you know, I would say more challenging backdrop from an economic perspective.

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Yeah.

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So look, you've both explained why there is resilience, and it seems like some of this relative strength will likely continue for some time.

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Other areas will come under pressure.

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As we look into the last few months of the year, what really are you looking for?

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From an economist standpoint, I'll be keeping a close eye on the job market right now.

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The job market has been quite interesting over the past half decade.

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I think many economists have talked about how essentially labor turnover is a bit low.

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So, you know, you hear a lot about this low hire, but also low fire economy.

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And it's a little bit difficult to disentangle.

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Well, how much of that is just the aftermath of the COVID-19 pandemic, where maybe businesses sort of rearrange labor into a...

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a much more effective place.

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And so maybe that's a contributing reason for low labor turnover.

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But then, you know, you look into the future and what everyone is talking about.

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Of course, it's all about AI.

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It's all about whether AI can be a replacement for labor.

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Now, you know,

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I think the way we look at these aggregated statistics, economists generally think that the evidence for a big turnover has yet to fully appear.

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But then again, it's clear that this is a transformative technology that will have big impacts on different industries.

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And so I just think it's going to be very important.

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As I mentioned, the Fed, in a way, is not paying as much attention to the labor market as it usually does because the unemployment rate is low at close to 4%.

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But if that changes, well, then the focus of monetary policymakers will change as well.

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Interesting.

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So in some ways, the AI impact on employment, that is a potential turning point that you're looking for.

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I think it's one of the most important ones as we go into the next year for sure.

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I mean, two things on my side to look out for going into year end.

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One is the earnings season, which has just started.

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The earnings season has become probably the most important event for equity markets.

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Since really the start of 2025, the S&P 500 has gained 4% during earnings seasons.

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Outside of earnings seasons, it's gained on average 0%.

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So the earnings season has been a catalyst every single quarter to basically reaffirm that, you know, AI revenue, non AI revenue is materializing and can sustain equity markets moving higher.

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So that is incredibly important to watch out for.

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The second thing is these big IPOs around the AI companies themselves.

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Anthropic is expected worldwide.

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to IPO later this year.

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That I think will be another big event to basically assess the appetite.

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And also it'll be the first opportunity for us to really see the details of the income statement, the balance sheet of these companies, and to understand whether it's potentially profitable and can sustain all of this high levels of capex and investment.

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So, of course, in the meantime, we'll still be watching Bond Yields, but it's really all about AI developments in the short term and the longer term.

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So thank you both so much and look forward to an update as we learn more.

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Thank you for having me.

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Thank you.

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That was Alistair Pinder and Ryan Wang on the outlook for equities and the US economy.

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And a reminder that we have lots more content available to you from Global Investment Research.

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If you'd like to hear more on Asia, then listen to our sister podcast, Under the Banyan Tree.

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This week, talking about data centers, so very relevant to what we've just discussed.

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And head to the HSBC CIB YouTube channel to watch our interview series discussing the rapid development of digital assets and currencies.

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But that's all from us here this week on The Macro Brief.

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This episode was hosted by me, Aline Van Dyne in New York, and produced by Tom Barton in London.

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Don't forget to like and subscribe wherever you get your podcasts.

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So until next week, thanks very much for joining us.