Bonds are Driving the Market. Or Are They? — 2026-08-31
Core thesis: Stocks are decoupling from rising rates because earnings growth is outpacing the cost of capital, but this divergence will eventually resolve—the question is at what level of rates it breaks.
Key points:
- Rate moves are real: 2-year yields up 96 bps (3.38% → 4.34%) and 10-years up 82 bps (3.94% → 4.76%) since Feb 27; Friday alone saw 11 bps move in 2-years, largest since June 17 (Kevin Warsh's FOMC debut).
- Fed pivot narrative: CME FedWatch shows 66% probability of September hike (up from 36% pre-Jackson Hole); IBKR Prediction Markets show 56% "Yes" (up from 31%). FOMC focus has shifted from employment to inflation.
- Equity resilience despite headwinds: SPX +11.5% and NDX +17.6% over same 6-month period; corporate ROI still outpaces government debt yields.
- Valuation theory vs. reality: Higher rates should compress present value of future cash flows, but if earnings/cash flows rise faster than rates, valuations can still improve.
- Critical threshold unknown: 10-year yield above 5% (last seen Oct 2023, June 2007) or a point where AI capex becomes uneconomic could be the breaking point.
Takeaway: Stocks and bonds remain on divergent paths until rates reach a level where either mechanical resistance (5% on 10-year) or economic logic (AI funding costs) forces a repricing. Watch for that inflection point; until then, earnings trump rates.