9-24 26 Will the Next Trade Be Bonds?

The normalization of interest rates after the unusually suppressed 2008–2021 period is raising refinancing costs for companies that borrowed at 2%–3% and may now face rates of 5%–7%, putting pressure on margins, hiring, capital expenditures, and consumer demand. Small- and mid-cap stocks are especially exposed because they are more sensitive to economic activity and borrowing costs, helping explain their recent weakness relative to large technology companies.

The speakers described high rates as potentially self-correcting: weaker demand could produce disinflation or deflation, eventually pressuring rates lower. This view contrasts renewed price pressure in manufacturing indexes, partly tied to higher oil prices and capital spending, with five-year breakeven inflation near 2.30%–2.35%; if inflation fell toward 1%–2% or growth weakened materially, bonds could rally as investors sought lower yields.

Fixed income has become a more credible alternative to equities now that roughly 84% of fixed-income assets yield above 4% and five-year Treasuries offer about 5%, versus long-run equity returns near 8%. The speakers expect higher yields could encourage gradual equity-to-bond rebalancing, while their credit preference favors higher-quality double-A bonds that may add roughly 20–40 basis points over Treasuries without relying on lower-rated debt.