Rising tech bond yields: One of the factors for the invalidation of Besant's "put option"

Nomura Securities pointed out that the competition for funds between US Treasury bonds and tech giant corporate bonds is one of the key reasons for the recent failure of Bessonette's "put option," and the global upward trend in yields is expected to continue.

Last week, the spread of major tech companies’ corporate bonds widened rapidly, with some reaching historical highs for this cycle. Nomura strategists noted in an August 24 report that this phenomenon has resulted in a scramble for funds between US Treasuries and tech bonds, pushing up long-term yields. As a result, Treasury Secretary Bessonette’s attempts to suppress long-end rates through policy maneuvers—the so-called “put option”—have been weakened. Meanwhile, concerns are rising over the Federal Reserve potentially lagging behind the curve.

The impact of the widening tech bond spreads has already spread to both the stock and bond markets. Last week, the US 10-year real yield continued to climb, reaching 2.40%, which has fully retraced to levels seen before the Treasury Department announced increased bond buybacks. Currently, the market has priced in a 40% probability of a rate hike in September, with a cumulative probability of 65% by October. The 2-year forward OIS rate (a proxy for the terminal rate) has also climbed further to 4.02%.

The widening of credit spreads has not yet spilled into broader markets, and the relative performance of bank stocks—an early indicator of tighter credit—has not shown a declining trend. However, analysts believe the situation warrants close attention. For the Japanese market, weakness in US Treasuries poses a direct drag, and both Japanese bonds and equities are expected to face pressure early this week.

Last week, the spreads of bonds issued by tech giants widened rapidly, with some hitting cycle-high records. Nomura pointed out, this is one of the main reasons for the continued rise in long-end yields—in addition to allocating to US Treasuries, investors are facing fierce competition for funds from tech corporate bonds. The ebb and flow between the two is putting downward pressure on Treasury prices.

This pressure has had a negative impact on both equity and fixed income markets. Last week, US tech stocks were mixed: semiconductor stocks fell, while hyperscale cloud and software stocks rose. Consumer-related stocks saw a strong rebound, but other cyclical sectors remained generally weak. In the bond market, the US Treasury yield curve flattened bearishly, with the short end leading the downward move as rate hike expectations increased.

Nomura stated that the current widening of credit spreads has not yet expanded into a broader tightening of credit, nor has the relative performance of bank stocks—as a leading indicator of tighter credit—shown a clear downward trend. Nevertheless, they believe the current situation merits continued and close monitoring.

The idea behind the Bessonette "put option" is that the market expects Treasury Secretary Bessonette to use policy intervention to support long-end US Treasury yields and dampen any excessively fast increases. However, Nomura believes that the competition for funds between tech bonds and Treasuries is one of the main reasons this protective mechanism has failed to function.

At a macro level, concerns about the Federal Reserve lagging the situation also add to the pressure. Nomura warns that Fed Chairman Kevin Warsh may underestimate the impact of artificial intelligence on economic growth and inflation, and may also underestimate changes in financing supply and demand, resulting in fiscal and monetary policies that are too loose relative to actual economic conditions—at least, this is how the market perceives it. Unless the Fed directly addresses these issues and signals an intent to correct course, concerns over its lagging response are unlikely to dissipate.

In the latter half of this week, Warsh will speak on Friday, and his interpretation of the current rate rise will be a key market focus. Meanwhile, Bank of Japan Deputy Governor Shinichi Himino is scheduled to speak on Thursday, with the market heavily expecting a hawkish signal from the BOJ—the probability of a rate hike in September is already at 82%, higher than the Fed’s 40% for the same period. Nomura expects Himino may hint at a September rate hike but is unlikely to elaborate on the path thereafter, and the terminal rate expectation (2-year forward OIS rate currently at 2.21%) is also unlikely to see major changes.

The market’s main focus is expected to shift noticeably between the first and second halves of the week. The first half focuses on the micro level, particularly the US tech earnings season—not only the reaction in the equity market but also in tech corporate bonds. The latter half will shift to macro drivers, with Japanese and US monetary policy leading the trends.