Global Markets Brace for Potential Correction Amid Rising US Yields and Debt
The global financial markets are facing significant headwinds that could lead to a substantial correction before the end of the year, impacting markets worldwide, including Israel. A key concern is the rising yield on U.S. ten-year bonds, currently around 5%, a level not seen since October 2023 and reminiscent of the period before the 2008 financial crisis. The U.S. Treasury is attempting to lower long-term yields by issuing short-term bonds to buy longer-term ones, but this effort has not yet succeeded. Persistent U.S. budget deficits, exacerbated by the conflict with Iran, are driving up interest payments, which now amount to a trillion dollars annually, or $1.25 trillion including payments to government funds.
Japan's shift in monetary policy is also a contributing factor. After decades of negative or near-zero interest rates, which led Japanese institutional investors to heavily finance the U.S. deficit by purchasing U.S. bonds, the Bank of Japan began raising rates in March 2024. This has made Japanese bonds more attractive, causing a reduction in Japan's holdings of U.S. debt, which fell to $1.12 trillion in June from approximately $1.3 trillion in 2021. U.S. Treasury Secretary Janet Yellen is reportedly pressing Japan to continue buying U.S. debt, reminding them of the security alliance.
Many countries, including China, Poland, and Turkey, are increasing their physical gold reserves as a hedge against U.S. dollar dependency, a trend known as de-dollarization. This diversification away from U.S. debt is expected to intensify as Japan's fiscal year ends in March 2027, potentially leading to further upward pressure on U.S. bond yields. The freezing of Russian assets following the invasion of Ukraine has also prompted other nations to seek alternatives to U.S. investments.
High U.S. interest rates and bond yields are making U.S. investments less attractive compared to the safety of bonds, leading to a decline in the stock market's appeal. The P&S 500 index's price-to-earnings ratio is currently around 26, significantly higher than the historical average of 15, indicating that stock prices are overvalued. A continued rise in yields could trigger a sharp correction, potentially causing stock prices to fall to more average levels.
Technology companies, particularly those in artificial intelligence, have significantly increased their debt issuance, raising hundreds of billions of dollars. Some estimates suggest total corporate obligations, including those hidden in long-term service contracts, could reach $1.65 trillion. The difficulty in rolling over this debt at high interest rates, coupled with concerns about AI's potential risks and the lack of international coordination with China on regulation, could lead to a market correction by mid-December. The Federal Reserve may also raise interest rates further after its October 27-28 and December 8-9 meetings to combat inflation, potentially stabilizing the financial markets and even benefiting stocks if it signals a reduction in future inflation expectations.
