The dangerous 5% threshold
Morning Observers,
The 10-year yield was just a hair from 5% this morning, a threshold it has reached only once since 2007. Will it finally break this bull market?
There are a number of analysts who guesstimate that 5% could be a point at which investors start selling stocks.
Although each one's model is different, all of them effectively boil down to competition for capital.
The S&P 500 currently trades at 19x earnings, which translates to an earnings yield of 5.3%.
That's very close to what you can earn from 10-year Treasuries, virtually guaranteed, without taking the extra risk of owning stocks.
Considering the S&P 500 has, on average, "outearned" longer-duration Treasuries by 2.5% since 2000, will investors eventually jump ship?
There's some nuance to this relationship that makes it hard to draw a hard line.
For starters, stocks' earnings yield can change quickly if earnings expectations change. That's what's happening right now. Against all expectations for a slow Q3, analysts have almost unanimously raised their earnings estimates.
And that's one of the reasons stocks have held up lately.
Today's earnings also create an interesting paradox. Higher yields tend to hit tech stocks the hardest. But since AI is now the biggest driver of earnings, the stocks that are supposed to tumble are actually the ones holding up this rally.
Then it's not some specific threshold but rather the speed at which Treasury yields rise that has the most impact on stocks.
Since 1940, 10-year Treasury yields have had no clear relationship with future S&P 500 returns, according to a Goldman Sachs analysis.
Historically, high Treasury yields often became a problem when they rose by two standard deviations in one month. That's about twice as fast as yields rose over the past month.
On the other hand, 5% with peace of mind is nothing to sneeze at. Q3 earnings better be good.
- Dan Runkevicius, Editor
⚠️ 10-year Treasury yield flashes a warning sign
The 10-year Treasury yield crossed 4.9% on Thursday for the first time since November 2023, extending its rise to 95 basis points since the Iran war began. More tellingly, the yield has climbed another 10 basis points since the Treasury announced plans this week to triple long-term bond buybacks to $6 billion.
🛢️ U.S. oil climbs above $100
U.S. crude surged above $100 a barrel Thursday for the first time since May 21 after another key Middle East shipping route came under threat. Yemen's Houthis seized the port city of Mocha and are advancing toward the Bab el-Mandeb Strait, a major chokepoint connecting the Red Sea with the Gulf of Aden. U.S. crude prices have now risen more than 50% since July 2.
📈 Higher producer prices add to rate-hike bets
U.S. producer prices rose more than expected in August, adding to concerns that inflation is picking up again. The Producer Price Index increased 5.4% from a year earlier, above expectations for 5.3%, while core PPI rose 4.6%. July's headline and core readings were also revised higher. Combined with oil's return above $100 a barrel, the Fed may have a hard time finding excuses not to raise rates.
📉 U.S. stocks fall for a fourth straight day
U.S. stocks declined for a fourth consecutive session Thursday, with the S&P 500 falling 0.6%. Materials, energy, and information technology stocks led the declines. The four-day losing streak marks a notable change for a market that had largely shrugged off the Iran war, with selling now spreading across several major sectors.
🤖 OpenAI ends $1 government pilot
OpenAI is ending the $1-a-year pilot that gave federal agencies access to its models and replacing it with usage-based pricing beginning Oct. 1. The change follows a pilot that the GSA says helped government agencies generate $1.4 billion in cost savings, turning what began as a heavily subsidized trial into a much larger commercial relationship.
DeepSeek’s 83% API margin puts OpenAI and Anthropic on notice
DeepSeek built its reputation by making powerful AI models significantly cheaper. Now it appears to be earning unusually high margins at those prices.
The Chinese AI lab generated $70.7 million in revenue through July, roughly 10 times what it made in all of 2025. But what stands out is how much of its API revenue it keeps.
DeepSeek’s unlikely margin advantage
DeepSeek reported an 82.9% gross margin on API access through July. That's more than 2x OpenAI's 39% company-wide gross margin in the first quarter.
The comparison isn’t perfect.
DeepSeek’s overall gross margin was 44.6%, and the company still lost roughly $106 million through July. But the API numbers help explain how DeepSeek can keep its prices so low.
The company appears to spend significantly less for every dollar it earns from API access, giving it room to compete aggressively on price while still earning strong margins.
What chip restrictions accidentally created
DeepSeek had access to fewer advanced chips than its U.S. rivals.
American export controls limited China’s access to Nvidia’s most powerful hardware, forcing the company to do more with less computing power.
State Street recently argued that AI could be following a familiar pattern.
The first country to develop a new technology often bears the highest cost, while those that follow can learn from what worked and catch up for much less.
DeepSeek may be doing exactly that. China has narrowed the AI performance gap without matching the enormous sums U.S. companies are spending on infrastructure.
📌 Bottom line: DeepSeek’s margin trajectory suggest Chinese AI companies could eventually udercut American pioneers, forcing LLMs into commodity pricing.
Bessent: "I'm the house now"
Treasury Secretary Scott Bessent isn’t just talking up the yen anymore. He’s trying to make betting against it dangerous.
His message to traders this week was remarkably direct. Washington knows what Japan is likely to do, and anyone shorting the yen may find out the hard way.
The threat is already doing some of the work
“I am the house now,” Bessent said at a Southern Methodist University event this week.
When Washington intervenes in the Japanese currency market, he said, he has “pretty good insight” into what the Bank of Japan is going to do.
It’s an unusually blunt warning from a Treasury secretary. Traders shorting the yen now face the possibility that Washington and Tokyo could suddenly step in together, as they did on July 31.
Commerzbank’s Michael Pfister argues that the threat alone may keep traders from piling back into yen shorts. The dollar has already fallen from nearly 164 yen before the joint intervention to around 153 this week.
Bessent can only do so much
There’s another reason traders aren’t rushing to short the yen: they expect Japan to keep raising rates.
A BoJ rate hike next week is already fully priced in, while markets expect another 90 basis points of hikes by the middle of next year, according to Commerzbank.
Pfister argues that Bessent’s warning could deter another round of yen selling, but further gains may depend on what Japan actually does.
📌 Bottom line: Bessent has made shorting the yen a bet against the U.S. Treasury and Japan at the same time. The question is how long the threat works before traders demand action.