Produced by | Miaotou APP

Author | Ding Ping , Huxiao APP

Header image | Visual China

Warsh is not the storm itself, but he may make the market realize that when the storm comes, the Federal Reserve is no longer in the same position as before.

Over the past two years, tech giants such as Nvidia, Microsoft, and Meta have continuously broken market capitalization records. AI has almost redefined the risk appetite of the entire market, and the S&P 500 and Nasdaq have also been driven up.

However, if we break down this round of market activity, AI is actually just the story in the spotlight. What truly supports the valuation of US stocks is another more crucial premise: long-term interest rates will eventually come down.

Only if this premise holds true will the market dare to continue paying high premiums for long-term profits, dare to continuously discount the growth narratives of a few leading technology companies to today, and dare to continue chasing valuations of 30, 40, or even higher.

But now, this premise is becoming unstable.

The yield on 30-year US Treasury bonds has continued to rise, recently breaking through the 5% mark. For a highly concentrated, expensively valued US stock market that relies heavily on long-term earnings narratives, the longer long-term interest rates remain high, the more fragile the valuation system becomes.

What's more troublesome is that this pressure may increase over time.

On May 15, Jerome Powell, who had served as Chairman of the Federal Reserve for eight years, officially stepped down, and Kevin Warsh became the next chairman. Compared to Powell, Warsh may be more tolerant of market pressure, more committed to quantitative tightening, and reduce the Fed's implicit support for the financial markets.

If long-term interest rates continue to rise and the Federal Reserve stops reassuring the market as quickly as it has in the past, then the prosperity logic that has supported the high valuations of US stocks in the past may begin to lose its support.

The current fragility of US stocks

The problem is that long-term interest rates cannot be lowered .

In the past period, the market has focused too much on whether the Federal Reserve will cut interest rates, ignoring the fact that long-term interest rates are no longer following monetary policy.

In theory, a central bank rate cut directly lowers short-term interest rates. If the market believes that interest rates will remain low in the future, long-term interest rates will follow suit. However, an unexpected situation has arisen: even though the Federal Reserve has not raised interest rates, the 30-year US Treasury yield continues to rise, reaching a high of 5.13% on May 15. This indicates that the market does not believe that long-term risks in the US will decrease, and therefore demands higher risk compensation.

This is precisely where the US stock market is most vulnerable right now.

There are at least three reasons why long-term interest rates are pegged to high levels.

First, inflation did not fall as smoothly as the market had expected .

Latest data shows that the US CPI rose 3.8% year-on-year in April, a near three-year high, while core CPI rose 2.8%. More concerning is that the risks of the US-Iran conflict have not truly subsided, and persistently high oil prices are constantly reinforcing market concerns about imported inflation. As long as inflation expectations cannot be completely suppressed, long-term interest rates will find it difficult to fall smoothly.

Second, the US fiscal problems are also undermining market confidence in its long-term fiscal constraints .

In October 2025, the US national debt reached the $38 trillion mark; just five months later, this figure surpassed $39 trillion. Behind this is a long-term fiscal deficit (high military spending and social welfare expenditures). The US Treasury repays maturing old debt by issuing new bonds, but these new bonds bring even higher interest payments, thus plunging the US into a Ponzi scheme of fiscal debt, requiring the ever-expanding scale of debt to maintain the stability of the existing system.

Third, the supply and demand structure of US Treasury bonds is deteriorating .

On one hand, the Treasury continues to increase bond issuance; on the other hand, overseas entities are reducing their holdings because the world is moving away from the dollar. Foreign official institutions are reducing their holdings of US Treasury bonds, and the proportion of US Treasury bonds in global reserve assets is declining, currently at 24%. Supply is increasing, but the buying power is weakening, resulting in long-term interest rates becoming increasingly difficult to suppress.

When the aforementioned risks are not mitigated, US Treasury bonds will no longer be considered safe assets, and investors will naturally demand higher risk compensation.

This is especially dangerous for US stocks.

Because the current US stock market is not a generally undervalued market that gradually realizes its value through performance, but a highly concentrated market supported by a few leading companies and extremely sensitive to the discount rate.

If long-term interest rates remain high, the discounting of future cash flows will become significantly more aggressive, and the tolerance range for valuations will narrow rapidly. At that point, the companies with the worst fundamentals will not necessarily be the first to be impacted, but rather those with the best fundamentals but whose valuations have already been driven to their maximum.

Bank of America's Hartnett also stated that once the 30-year US Treasury yield rises above 5%, market financing costs will increase and risk appetite will decline, with highly valued US technology stocks bearing the brunt.

It was demonstrated once in October 2023.

At that time, the 30-year Treasury yield briefly rose above 5%, and the Nasdaq index had cumulatively corrected by about 10% over several months. Investors still believed that if financial conditions continued to deteriorate, the Federal Reserve would eventually send reassuring signals. However, if this expectation begins to waver after Warsh takes office, then the market will react very differently to the same long-term interest rate shocks.

Many people like to draw parallels between 2007 and today, but what's truly worth learning isn't that interest rates were high back then, but rather that the damage high interest rates inflict on the financial system is never instantaneous. It's more like a slow erosion: first, it suppresses financing, then valuations, then balance sheets, finally forcing the most vulnerable link in the system to the surface.

In 2007, the real estate sector, subprime mortgages, and shadow banking were the ones that truly collapsed. Today, what's more dangerous is that high fiscal deficits are pushing the supply of long-term debt higher and higher, making it impossible to bring down long-term interest rates. This will gradually force out unrealized losses in banks, tail risks in commercial real estate, and the dependence of risky assets on liquidity.

Therefore, once long-term interest rates fail to come down, the valuation basis of this AI bull market in US stocks will begin to weaken .

This problem will be even more serious in the Walsh era .

Why should the market be wary of Walsh?

Because Warsh favors quantitative tightening, it will further push up the yield on 30-year US Treasury bonds and amplify the vulnerability of US stocks .

How do we understand this?

The Federal Reserve's balance sheet reduction means shrinking the size of its balance sheet. Previously, to stimulate the economy, the Fed purchased large amounts of assets such as Treasury bonds and mortgage-backed securities (MBS); buying these assets was equivalent to injecting a large amount of money into the market. Balance sheet reduction involves decreasing these assets, gradually withdrawing liquidity from the market.

We can also simply understand it as the Federal Reserve not accepting new or maturing Treasury bonds issued by the Treasury, and may even sell off its own Treasury bonds.

As mentioned above, the US Treasury is currently increasing its bond issuance, while overseas entities are reducing their holdings. If the Federal Reserve also shrinks its balance sheet, then both new and maturing US Treasury bonds will have to flow into the market, where interest rates will be determined. This will result in a continuous rise in US Treasury yields. This will also lead to an increasingly heavy interest burden on the Treasury, which is extremely dangerous for a system that relies on issuing new debt to repay old debt. Once interest costs become unsustainable, a US debt crisis will occur.

Former U.S. Treasury Secretary Paulson also warned that once U.S. Treasury bonds begin to lose market buyers, the "risk-free anchor" of the entire financial system will be shaken.

Given the serious consequences, why does Walsh still favor reducing the balance sheet? This has to do with his resume.

Warsh served as a Federal Reserve governor from 2006 to 2011, an experience that is central to understanding his policy leanings. He fully experienced the last round of credit expansion before the financial crisis, the 2008 global financial crisis, and the onset of zero interest rates and QE (quantitative easing).

He wasn't one to completely deny the need for crisis intervention; on the contrary, at the height of systemic risk, he supported the Federal Reserve acting as lender of last resort and acknowledged the necessity of unconventional tools. However, he later became increasingly skeptical about whether long-term quantitative easing (QE) should continue after the crisis.

From his perspective, the US economy did not recover to the same extent as asset prices after the crisis. The recovery of the real economy was not strong, and productivity improvement was limited, but financial asset prices rebounded rapidly, driven by liquidity, even far exceeding pre-crisis levels.

This leads Warsh to a very typical conclusion: QE may be very good at raising financial asset prices, but it may not be as good at repairing the real economy. Once the market begins to assume that "the Fed will eventually support asset prices," the financial system will become increasingly dependent on liquidity, risk appetite will be suppressed in the long term, and asset bubbles and mismatches will become more and more serious.

Therefore, in his logic, if the Federal Reserve maintains its massive balance sheet and suppresses term premiums for an extended period, the market will eventually become increasingly unable to operate independently of central bank liquidity. In his view, balance sheet reduction is not only about withdrawing liquidity, but also about the Federal Reserve proactively withdrawing from its role as a "stabilizer of financial conditions."

This is why Walsh is more inclined than Powell to push for QT (quantitative tightening).

Therefore, with Warsh in charge, the high-interest-rate environment will become even more severe, and the Federal Reserve may not intervene as quickly as it has in the past. Once this expectation takes hold, the already fragile high valuation system of US stocks will face further amplified pressure .

AI narratives also cannot absorb high interest rates.

Of course, the continued high yield on 30-year US Treasury bonds is not necessarily a negative factor for US stocks.

If the US economy continues its stronger-than-expected performance, corporate profits are revised upwards, and especially if AI can truly and rapidly translate into widespread productivity gains, then even with persistently high interest rates, risky assets may not be unable to withstand the pressure. Ultimately, what truly determines whether the market can absorb high interest rates is economic growth itself.

The reason why US stocks, especially technology stocks, have been able to continue to rise in the past year in a high-interest-rate environment is largely due to the optimistic view that AI will significantly improve corporate profits, boost productivity, and open up a new round of growth space for the US economy.

However, the problem is that the AI ​​narrative is currently more focused on a few leading companies and the capital market, and has not yet been fully proven to be able to quickly and widely translate into fundamental improvements in the entire economy.

Take Nvidia as an example. It has indeed created amazing returns on capital and market imagination. However, such companies have common characteristics: high technological barriers, high profit concentration, and limited job creation capacity (as of fiscal year 2026, Nvidia's total number of employees worldwide was only 42,000). Their spillover effect on the overall economy is not as strong as market sentiment suggests.

In other words, AI can boost the valuations of companies like Nvidia and Microsoft in a short period of time, but it may not be able to support broader employment, investment, and expansion of the real economy in the same short period of time.

More realistically, the United States is currently facing problems with insufficient electricity, infrastructure, and industrial support. The faster the AI ​​industry expands, the easier it is to attract capital, energy, and talent to leading technology sectors, further concentrating the already uneven allocation of resources in these sectors.

This is not to say that AI is ineffective, but rather to emphasize that it is not yet fast enough to cover the valuation pressure brought about by the high long-term interest rates .

In other words, while the market thinks it's trading in AI, it's actually trading in something else entirely: low long-term interest rates and the Federal Reserve's support. As long as these two premises remain, the high valuations can continue; once these premises begin to loosen, even the most powerful AI will only delay the revaluation, not cancel it.

Walsh is not the source of the risk, but he may be the one who makes this situation more difficult to reverse .

In short, while Warsh may not intentionally create a crisis, he may have made the market truly accept for the first time that the high valuation logic that was previously supported by low long-term interest rates and the Fed's intervention is no longer so stable .