US Strategy Weekly: “Storms Make Trees Take Deeper Roots”

“Storms Make Trees Take Deeper Roots” – Dolly Parton

Some market environments are easier than others and in 2026 the daily ups and downs of the equity market have been predictably the inverse of crude oil. This held true again this week, despite a flurry of news that included a possible trade war with Canada, Treasury Secretary Scott Bessent announcing significant “D-Day” sanctions on Iran and the Treasury’s controversial announcement to double the size of Treasury buybacks.

After the 30-year Treasury bond yield spiked to a 19-year high of 5.3%, Treasury Secretary Scott Bessent announced a repurchase program for longer-dated Treasury securities that could potentially exceed $4 billion per issue. Secretary Bessent explained that this was to provide liquidity to the thinly traded long end of the yield curve and to help stabilize mortgage rates. As seen in the chart on page 3, the 30-year bond yield has been rising faster than the 10-year or 5-year. Bessent’s program will buy back long-term debt and replace it with short-term debt. This program is similar to “Operation Twist” which the Treasury initially launched during the Kennedy administration to stimulate the economy and was used by the Federal Reserve after the 2008 financial crisis to stabilize the banking system.

Although this is not an unusual operation, Bessent has been widely criticized by the press and prominent economists. We agree that government intervention in the debt markets rarely has any significant long-term effect, but Secretary Bessent acknowledged this when he said he was simply signaling the market during a quiet August period. We would note that the 30-year bond yield has been rising much faster than the rest of the Treasury curve and much of this is due to the huge issuance of corporate debt related to AI. There is little that Secretary Bessent can do about this debt issuance. Nevertheless, the 30-year yield is up 22 basis points since the end of June and the 2-to-30 yield curve has increased 100 basis points, while the 2-to-10 yield curve is up a mere 10 basis points. See page 3.

Despite the recent hysteria in the financial press regarding rising interest rates, rising federal debt, and the ineffectiveness of Treasury intervention, the current Treasury yield curve looks quite similar to the average long-term yield curve, although the current curve is less steep and yields are well below the historic averages. In short, the current curve is more favorable than the long-term norm. It is also worth noting that the 10-year Treasury yield, which is the normal benchmark for fixed mortgage rates, has been trading in a tight 14 basis-point range between 4.6% and 4.74% for the last four weeks. In other words, little has happened. See page 4.

But debt markets have been jittery due to massive bond issuance by major hyperscalers which now exceeds $220 billion in 2026 and is projected to hit $750 billion in the near future. In addition to these bond sales, hyperscalers have billions of dollars tied up in off-balance sheet commitments, long-term financing of infrastructure, and lease obligations. Many analysts question whether revenue at these hyperscalers will justify this massive investment. This concern is justified; but in our view, it also means Treasury debt should be the safe-haven asset.

The risk to our optimistic view is the buildup in federal debt. As of July, total gross federal debt reached $40.03 trillion. This received considerable attention, as it should, particularly since the cost of servicing this record debt is now more than $1.17 trillion annually and represents roughly 19% of total federal outlays. Nonetheless, this mountain of debt has not been Treasury Secretary Bessent’s doing, yet it did cause a stir when July’s monthly deficit of $432.3 billion reached 1.3% of GDP. The 12-month sum of deficits hit 6% of GDP at the end of July and this administration has been criticized harshly. But as Bessent indicated in his press conference, recent deficits are a result of tariff refunds mandated after the Supreme Court decision in February. These refunds, combined with a loss of corporate and personal tax revenue from the One Big Beautiful Bill, added to the deficit in recent months. The tariff paybacks are a one-off factor and the corporate tax deductions that materialized due to capital expenditures should be stimulative and provide efficiencies to the economy over the long run.

Looking ahead, tariff refunds are complete and new tariffs have been introduced that will produce revenues going forward. In short, federal deficits should moderate in the final quarter of the year. Still, it is worth noting that annualized deficits-to-GDP averaged 8% during the four-year Biden administration and this did not get any coverage by the press. The Trump administration inherited a debt-to-GDP of 7.2% in January 2025, and brought this was down to 5.2% as recently as May 2026. Secretary Bessent is the only Treasury Secretary in our recollection that had any plan for deficit reduction. Bessent’s goal is to get annualized debt-to-GDP to 3% and to generate GDP growth in excess of 3%. This would be a sustainable trend. We expect the Secretary will lower debt-to-GDP by year end. Meanwhile, the Congressional Budget Office (CBO) forecast, which is rarely accurate, has federal debt rising to 136% of GDP by 2036. But this estimate includes a slowdown in GDP, rising interest rates, and weaker employment. See page 5.

Despite the concern over rising long-term interest rates and the uncertainty of the Iran conflict, the S&P 500 index is trading a mere 1.5% below its record high. This does not surprise us since earnings have been stellar over the last twelve months. The current one-year trailing earnings growth rate has reached 29.6% YOY, as compared to the long-term average of 8.1% YOY. After adjusting for inflation, this growth rate is 26.2% YOY and the highest since March 2022. However, going back to 1948, earnings growth has only been this high or higher (excluding rebounds from a recession) in 2018 and 1988. The 1988 earnings rebound materialized after the Crash of 1987, which did not generate an economic recession, but did slow earnings growth, hence the rebound. The 2018 earnings peak was during the first Trump administration, and it followed the overhaul of the US tax code (Tax Cuts and Jobs Act of 2017) which strengthened the economy. While we believe the One Big Beautiful Bill has given a boost to the economy, the strength of the current earnings season should spur questions about whether we are approaching a peak in earnings growth. We believe this is likely, and as we wrote earlier in the year, it will become increasingly more difficult for companies to generate positive earnings surprises.

For a variety of reasons, the August/September months tend to be a tricky time for equity investors, and we expect this will be true in 2026, particularly since it is a midterm election year. But overall, we believe equities are supported by solid earnings and valuations are reasonable. We remain a buyer on weakness.   

This was a quiet week for economic news, but new home sales were down 6.3% YOY. The regional data was mixed showing sales falling in the Midwest and South but increasing in the Northeast and West. The inventory of new homes for sale was up 1.9% over the month to 488,000 units, representing 9.6 months of supply at the current pace of sales. The median price of a new home was $393,800, down from $397,300 a year ago. In sum, the residential housing sector remains weak and rising rates would be an additional handicap.

Gail Dudack

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