Morgan Stanley: The bond market has pre-emptively tightened financial conditions for the Federal Reserve, while moderate CPI may drive the US stock rally to broaden.

Mike Wilson, chief US equity strategist at Morgan Stanley, stated that the yield on the 10-year US Treasury has risen by around 120 basis points since February. Coupled with a stronger US dollar and high oil prices, financial conditions have tightened significantly, with the bond market pre-emptively fulfilling some of the tightening tasks that the Federal Reserve would have otherwise achieved through interest rate hikes. If this process is sufficient to curb economic demand, the Fed may not need to raise rates further in the future. Wilson noted that the US September CPI will be released this Wednesday. If inflation continues its moderate decline, it could ease upward pressure on long-term interest rates and reduce market expectations of additional rate hikes. He advised focusing on bond market volatility and the performance of financial stocks to determine whether financial conditions are stabilizing. Wilson believes the recent resilience of US stocks is mainly driven by large AI-related stocks. The S&P 500 market-cap weighted index has performed significantly better than its equal-weighted counterpart, reflecting that the pressure of high interest rates on most stocks has not yet faded. If bond market volatility declines and bank earnings reports are solid, the market rally could potentially spread from AI leaders to more sectors. He also pointed out that the current rise in US Treasury yields partly reflects capital demand from AI infrastructure investment, rather than purely recession risk.