As the editor-in-chief of MarketScreener pointed out in his morning column, stocks in both the US and Europe are continuing their rally, leading us to wonder what could derail this well-oiled machine.

Amongst factors that could slow the rise in stocks is higher interest rates. Why? Because when bond yields are higher, bonds become more attractive relative to stocks. And because stock valuations are based on the discounting of future earnings. So, the higher interest rates are, the lower the present value of future earnings, which normally tends to weigh on stock prices.

United States: a downgrade and tax cuts

There is every reason for rates to rise in the United States. Following S&P in 2011 and Fitch in 2023, Moody's downgraded the US credit rating on Friday from Aaa (the highest rating) to Aa1.

Of course, Treasury Secretary Scott Bessent had no trouble saying that Moody's is a "lagging indicator" and that this is the result of the previous administration's policies.

He is right on two counts. First, investors have learned little new about the US budget situation. Second, "Bidenomics" has indeed widened the deficit a little more.

However, the policy he is advocating does not seem to be really geared towards restoring public finances, despite a stated goal of reducing the deficit to 3% of GDP.

Indeed, Republicans in Congress are currently working on a tax cut plan that, according to the Committee for a Responsible Federal Budget, is expected to add $3.3 trillion to the deficit over 10 years.

This situation echoes Moody's statement justifying the downgrade of the US credit rating: "Successive US administrations and Congress have failed to agree on measures to reverse the trend of large annual budget deficits and rising interest costs."

As a result, the 30-year rate reached 5.04% yesterday, its highest level since October 2023.

Japan: where are the buyers?

In Japan, too, bond markets are tightening. The Japanese 20-year bond hit its highest level since 2000, at over 2.5%.

There has been no downgrade here, as Japan – whose public debt stands at 237% of GDP – lost its famous AAA rating long ago. However, with this level of debt, the market is watching investor demand for bonds very closely.

And that is where the recent surge in rates comes from: weak demand for a 20-year bond auction. To measure this, bond managers use the bid-to-cover ratio – demand for securities divided by supply. This is at its lowest level since August 2012. Another sign of weak demand is the tail, which measures the difference between average prices and the lowest accepted prices, which stood at 1.14, its highest level since 1987.

For Shoki Omori, strategist at Mizuho, the auction results highlight "the persistent weakness in supply and demand in the very long-term bond sector and fuel concerns about who, if anyone, will step in to buy."

Although foreign investors bought record amounts of super-long bonds (maturing in more than 30 years) in April, the most important players in this market are domestic players. However, pension funds are reducing their exposure to Japanese bonds, while the Bank of Japan is currently reducing its balance sheet.

Sources: BoJ, JSDA, Bloomberg. Data as of March 31, 2025.

This pressure on rates also complicates the Japanese government's task, as it represents an increase in borrowing costs. Prime Minister Shigeru Ishiba even believes that "our country's budgetary situation is undoubtedly extremely bad, worse than that of Greece."