BofA warns 5.2% yields threaten AI bull market, force Fed hand

Thirty-year Treasury yields at 5.2%, the highest since 2007, are tightening financial conditions beyond what corporate earnings can offset, threatening the AI capex cycle.

The bond market's repricing is tightening financial conditions faster than corporate earnings can support, threatening the AI investment cycle and raising the risk the Federal Reserve will be forced to raise rates, according to Bank of America strategists.

"Financial conditions are tightening beyond what corporate earnings can support, and that could force the Fed to hike rates — the one outcome equity markets are not positioned for," Michael Hartnett, chief investment strategist at Bank of America, said in a July 27 note.

The 30-year Treasury yield climbed to 5.2%, the highest since June 2007, while the 30-year real yield reached 3%, a level not seen since November 2008. Two-year yields rose to 4.37%, their highest since February, and the benchmark 10-year yield touched 4.71%. Markets now price a 38% probability of a rate hike at the Fed's July 29 meeting and fully expect one by the Sept. 16 meeting, according to futures pricing.

The selloff has been led by real yields, showing traders are repricing the terminal fed funds rate higher. If the Fed delivers a hawkish surprise, Hartnett warned, the current "yields up, banks up" regime could flip to "yields up, banks down" — a trigger for broad risk-asset deleveraging. The next test comes July 29, when the Federal Open Market Committee announces its rate decision.

Real Yields Lead the Charge as Terminal Rate Expectations Reset

The 30-year real yield at 3% is the most telling signal. Real yields strip out expected inflation and reflect the market's view of the actual cost of capital. Leslie Falconio, head of taxable fixed income strategy at UBS Global Wealth Management, said the move reflects a repricing of where the Fed's tightening cycle will end. "Most of this rise is really by the real yield component, which is repricing the terminal Fed funds rate, and the fact that the growth outlook currently still remains on solid footing," she said.

Markets now expect the Fed's benchmark rate to peak near 4.23% next June, up from the current 3.50%-3.75% range. The implied path has shifted sharply since June, when a ceasefire between the U.S. and Iran briefly reduced rate-hike expectations. Renewed fighting has reversed that repricing, and lingering questions over how the Fed will respond are adding to the uncertainty.

That uncertainty is compounded by the Fed's communication strategy under Chair Kevin Warsh, who has deliberately reduced forward guidance to wean markets off central bank forecasts. "We got so used to eight years of the Powell Fed where they really didn't want to go into the pre-communications blackout with market expectations divergent from what the Fed was going to do," said Will Compernolle, macro strategist at FHN Financial.

Hyperscaler Credit Risk Hits Record on AI Spending Skepticism

The bond market stress is most acute in credit tied to the AI infrastructure buildout. Credit-default swaps on hyperscale cloud providers have surged to record highs, and bond issuance concessions have widened, reflecting growing skepticism about the return on the hundreds of billions of dollars being poured into artificial intelligence data centers.

Google and Intel posted solid earnings last week, yet semiconductor stocks sold off — a sign that the market's concern has shifted from whether AI companies can generate revenue to who will finance the spending. Hartnett's "blue collar semiconductor" basket — including Texas Instruments, Analog Devices, NXP Semiconductors and Microchip Technology — has fallen 21% from its June high.

The broader macro backdrop adds to the pressure. The U.S. government is running a $2 trillion annual fiscal deficit with $1 trillion in annual interest expense, even as tariff revenue has reached $250 billion over the past 12 months. Labor supply is constrained — initial jobless claims have fallen to their lowest since 1969 — while protectionist trade policies and disruptions to oil supply through the Strait of Hormuz are pushing up input costs.

Hartnett recommended investors rotate into defensive stocks, high-dividend equities and long-duration bonds while shorting banks, brokerages, technology and industrial stocks. He also identified Hong Kong property stocks as among the most attractive long-term buying opportunities, saying he would buy on any weakness triggered by Fed tightening or a yen crisis.

This article is for informational purposes only and does not constitute investment advice.