Bank of America Warns Bond Market is the 'Most Dangerous Variable' in AI Bull Market

The recent AI-driven rally in U.S. equities continues to captivate global markets. However, Michael Hartnett, Chief Investment Strategist at Bank of America, has issued a stark warning in his latest report: the bond market is becoming the primary source of uncertainty in this AI-fueled bull run.

According to reports from Caixin Global, Hartnett summarizes the current market environment as 'FCI > EPS'—meaning the negative impact of tightening financial conditions (FCI) has now fully outweighed the positive support from improving corporate earnings (EPS) for stock markets.

Hartnett's report highlights that the nominal yield on 30-year U.S. Treasury bonds has risen to 5.2%, the highest level since 2007; real yields have climbed to 3%, reaching their peak since November 2008; and prices of corporate bonds issued by U.S. tech firms have fallen to two-year lows.

The simultaneous deterioration of these three indicators suggests that systemic financing costs across markets are rising, and this risk has not yet been fully priced into equity valuations.

The report notes that since 2026, global central banks have already carried out 23 rate hikes, and Bank of America forecasts another 18 hikes globally this year. Market expectations now assign a 38% probability to a rate hike at the Federal Reserve's July 29 meeting, while a hike at the September meeting is already fully priced in.

Hartnett warns that disorderly rises in bond yields could force the Fed to raise rates to suppress inflation expectations and curb uncontrolled surges in long-term interest rates. However, such rate hike expectations are undoubtedly bearish for risk assets like equities.

He also points out that even though the White House may currently favor maintaining capital market stability, it could tacitly allow the Fed to hike rates—hoping that tighter liquidity will cool an overheated stock market. If this scenario unfolds, capital markets may face significant downward pressure.

Hartnett urges investors to closely monitor a key bull-bear signal: the current 'rising yields, strong bank stocks' combination, which characterizes a healthy bull market driven by economic strength. If this flips to 'rising yields, falling bank stocks,' it could directly trigger massive deleveraging across risk assets.

'Rising yields, strong bank stocks' indicates that higher rates are driven by strong economic fundamentals. In contrast, 'rising yields, falling bank stocks' signals market concerns that high rates may trigger credit tightening and economic downturns, leading to passive tightening of financial conditions and increasing the likelihood of risk asset deleveraging.

Who Will Pay for the AI Frenzy?

Bond market pressures have already spilled over into the AI sector. Credit Default Swap (CDS) prices for major hyperscale cloud computing giants have surged to record highs, and credit spreads continue to widen. Bond investors are beginning to 'vote with their feet,' and skepticism is growing over whether the ongoing wave of massive AI capital expenditures can deliver expected returns.

Rising CDS prices indicate that the market perceives a higher risk of corporate debt default, requiring investors to demand higher premiums to bear credit risk. The credit spread—the premium of corporate bond yields over comparable U.S. Treasury yields—widening reflects growing market concerns about corporate credit risk.

Market sentiment has clearly shifted: previously, capital focused on whether tech firms 'could be profitable'; now, the central question has become 'who will continuously bear the high costs of investment?' Google and Intel delivered solid earnings but were still sold off.

Markets fear that once the bond market stops providing low-cost funding for the AI industry's expansion boom, the expensive memory chips and numerous unprofitable frontier large language models will face severe funding gaps.

Brian Garrett, a derivatives trader at Goldman Sachs, previously issued warnings for two consecutive weeks: the core risk for AI stocks may not come from within the equity market, but lurks in the bond market. He also noted that the S&P 500 index can no longer reflect the true performance of individual stocks, as market dispersion rises and intra-sector divergence intensifies.

Industry insiders point out that while corporate earnings remain important for this AI bull market, as industry capex becomes highly dependent on debt financing and bond investors demand higher risk compensation, pressures are accumulating across valuation, credit, and liquidity dimensions.

The sustainability of the market rally may no longer hinge on whether chipmakers can deliver better-than-expected earnings, but on whether the bond market can continue to provide low-cost funding for the AI industry's next expansion cycle.