Capital Markets Update #32

Last week we tried to contextualize higher rates.  As a reminder, our research concluded that higher rates were ultimately acceptable, provided GDP growth kept relative pace.  Once the GDP to long rate relationship breaks and the gap between the 10-year Treasury yield and annualized real GDP growth expands beyond the historically sustainable 1% - 2.5% range for an extended period of time (call it 2 – 4 quarters), we could see a meaningful downturn in economic activity.  

A few additional things we’re thinking about as it relates to rates. 

The 10-year treasury is up about a point since February 2026.  Another way to think about this is a “risk-free” 10-year Treasury has lost about 10% of its value in 7 months.  So, risk free is down 10% while the S&P 500 is up 13%.  What defines this dichotomy?  WTI crude is up about 50% since the beginning of February.  Since 2/26, Core CPI has averaged approximately 0.212% MoM increase, which equates to a 2.54% annualized Core CPI rate over the 8-month period.  That’s hot, but not hot enough to move the 10-year yield a full point.  According to Reuters / Goldman Sachs data, hyperscaler 2027 debt issuance is expected to hit a record $250B this year and increase to an estimated $450B next year.   For reference, there’s about $4.4T of 10-year Treasury notes outstanding – in total (US Treasury Data).  About $210B of this total has been new-issued so far in 2026 and we can expect there to be about $250B worth of total 10-year note new issuance by year-end 2026.  Thus, reframing the $250B of 2026 hyperscaler debt issuance, you can say that the five investment grade companies are issuing long-term debt in an amount roughly equivalent to the total US Government 10-year new-issuance in 2026.  This tells us there’s exceptionally strong competition for fixed income investment dollars in the market today which depresses bond prices and, as a result, drives up bond yields.  

However, while we acknowledge the impact these stimuli have had on our risk-free markets and without being overly prescriptive , we ultimately can’t ignore the exceptionally strong relationship between oil prices and 10-year Treasury yields.  The two are too highly correlated at the moment. According to BMO, the one-month rolling correlation between front-month WTI crude and the 10-year Treasury yield has climbed to 0.96 as of 9/14/26.   According to the WSJ, the rolling 100-day oil / 10-year Treasury correlation reached its highest point recorded, over a 30-year study period, just a few days ago.  So, yes inflation is running slightly hotter than Fed target and sure there’s meaningful competition in the debt markets for yield.  Strong underlying economic growth has created additional competition for capital as investors favor equity over debt and yes global rates are rising.  However, is it feasible to expect a material snapback in bond prices once the market can confidently underwrite supply-demand balance in the oil markets?  Probably so. In which case this whole discussion should be entirely re-evaluated.  If we’re going to qualify the current 5.20% 10-year Treasury yield environment as tenuous but acceptable, a 4.20% rate environment with 3%+ GDP growth would be exceptionally compelling and should be recognized accordingly.  Lets hope we get there…

Separate but related to the 10-year Treasury yield discussion is a focus on US government credit.  US government creditworthiness is a complicated underwriting.  What isn’t complicated is the US Government is running a ~$1.8T (25% of budget) structural deficit in a full-employment, strong-growth environment.  Interest on our outstanding debt obligations represents over 50% of our deficit or about a $1.0B annual obligation (as of YE 2025).  While we do not think the US government deficit represents the driving force behind the current rising rate environment, undoubtedly it doesn’t help.  So, for better (not worse), high rates cause us to focus on deficits.  Deficits, practically, are pretty simple in that they only seem to be solved once it become a problem.  Here’s an interesting view on deficits – data from Worldbank and OECD.  France collects approximately 44% total annual GDP in taxes, has experienced a 1.1% average GDP growth rate for the last three years and has a debt to GDP ratio of about 113%.  Germany collects approximately 38% of GDP in taxes, has experienced -0.4% 3-year average GDP growth and has a constitutionally limited debt-to-GDP ratio of 64%.  Japan collects approximately 34% of GDP annually in taxes, has a 1.3% average 3-year GDP growth rate and has a debt to GDP ratio of 236%.  Great Britain collects approximately 35% of annual GDP in taxes, has a trialing 3-year GDP growth rate of 0.9% and a debt to GDP ratio of 101%.  FINALLY, the US collects approximately 25% of GDP in taxes, has a trailing 3-year GDP growth rate of 2.6% and a debt to GDP ratio of 120%.   We get it, lots of data, but the takeaways are pretty obvious to us.  Most notably, a high tax rate does not guarantee a lower debt burden – particularly the ability to decrease it over time.  The debt-to-GDP ratio for all countries has risen in lockstep since the 1990’s.  We’ll let pundits opine and argue as to whether paying 150% of taxes in the UK, Germany and Japan (nearly 200% in France) results in a corresponding improvement in quality of life.  But, what the data does not show is that higher tax rates help decrease government deficits over time.