'Eventually something will break': JPMorgan strategist warns rising bond yields could unleash a 'financial accident'

By Joseph Adinolfi

Here's one reason investors might consider betting on a bond-market rebound: If prices keep falling, and yields keep rising, it could trigger a financial catastrophe.

At least that is what one top J.P. Morgan Asset Management strategist said during an interview with "Bloomberg Surveillance."

Given the uncertainty around how the U.S. economy might react to sharply higher interest rates, David Lebovitz, global market strategist at J.P. Morgan Asset Management, said one would expect bond yields to be moving lower, not higher.

See: How 10-year Treasurys could produce 20% returns, according to UBS

Not to worry, bond bulls. If yields continue to climb, eventually the Federal Reserve will likely be forced to cut rates, Lebovitz said. However, here he offered a clarification that it would be foolish to expect the central bank to lower borrowing costs unless it has a specific motivation to do so.

"If rates continue to rise the way that they've been rising, eventually there will be a financial accident, eventually something will break and that will get the Fed moving in the other direction," he said.

Although stocks slumped during September, with the S&P 500 booking its worst monthly performance of the year, the fact that stocks remain relatively sanguine makes little sense to Lebovitz.

"But it seems like the equity market still has this idea that the Fed is going to ease for easing's sake in 2024, and I just can't get there," he added.

JPMorgan Chase & Co. CEO Jamie Dimon recently warned that investors and the general public aren't prepared for interest rates to go to 7%.

But some of JPMorgan's top markets minds expect yields' ascent to finally peak during the fourth quarter before they turn lower.

"The current move up in bond yields, even as Cyclicals are selling off, could be seen as a sign that the market is starting to price in a policy mistake, that potentially the Fed is going too far, and that 'higher for longer' will deliver pain. Given this, we do not think that bond yields will be able to keep moving up for too much longer, and will likely ultimately fall," said a team of strategists led by JPMorgan's Mislav Matejka, head of global and European equity strategy, in a recent research note.

Rising bond yields already helped cause Silicon Valley Bank and other U.S. lenders to collapse earlier this year. Worries that rising yields could stoke even more widespread problems have resurfaced as long-dated yields pushed higher in September. The yield on the 30-year Treasury bond BX:TMUBMUSD30Y rose 85.6 basis points during the quarter ending in September -- its biggest rise in any quarter dating back to 2009, according to Dow Jones Market Data. Bond prices move inversely to yields, falling as yields rise, and vice versa.

Rising yields on Monday put renewed pressure on stocks as an overnight rally in stock futures inspired by an unexpected deal to avert a government shutdown in Washington fizzled.

The yield on the 10-year Treasury note BX:TMUBMUSD10Y was up 6.9 basis points to 4.641% on Monday, nearing its highest level since Oct. 16, 2007. Yields are already trading at their highest levels in 16 years.

Unrealized losses on investment securities held by U.S. banks stood at $558 billion as of June 30, according to quarterly data published by the Federal Deposit Insurance Corp. That number was actually lower than a peak from the third quarter of 2022, largely because many banks have opted not to reinvest the proceeds from maturing bonds, according to a report in The Wall Street Journal. However, as yields have risen over the summer, many expect unrealized losses to have increased.

U.S. stocks were trading mixed on Monday, with the S&P 500 SPX up 8.4 basis points, or 0.2%, at 4,296 in recent trade, while a rally in most of the so-called "Magnificent Seven" megacap stocks helped lift the Nasdaq Composite COMP up 129 points, or 1%, to 13,348.

-Joseph Adinolfi

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10-02-23 1148ET

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