Where the 10-year yield is a ‘clear problem’ for stocks, says Goldman

Where the 10-year yield is a ‘clear problem’ for stocks, says Goldman

Traders work on the floor of the New York Stock Exchange (NYSE) in New York City, USA, April 29, 2024.

Brendan Mcdermid | Reuters

Bond market volatility has kept equity investors on edge for months, but at what point will rising yields spoil the stock market rally in 2024?

According to Goldman Sachs, the answer is 5% on the yield on ten-year government bonds. In a new 19-page paper using market data since the 1980s, the Wall Street firm says that when that threshold is reached, the correlation between bond yields and stocks becomes negative.

“While there is no ‘magic number’, historically bond yields around 5% are the point at which higher yields become a clear problem for equities – that is the point at which the correlation with bond yields is no longer decisively positive,” wrote a team from Goldman. strategists led by Peter Oppenheimer, the chief global equity strategist.

The benchmark 10-year yield rose 5 basis points to 4.67% on Tuesday after data showed employee payroll costs rose more than expected at the start of the year. It marked another sign of danger about persistent inflation, which the market believes will keep the Federal Reserve on hold until later this year before considering cutting rates. One basis point is equal to one hundredth of a percentage point.

Goldman said investors are currently in the “optimism phase” of the cycle, where confidence – and complacency – is growing, driving valuations higher.

“Equity valuations are higher and the cycle is more mature, so equity markets are very sensitive to movements in bond yields,” Goldman said. “They underperform as interest rates rise on news of overheating and higher inflation, while they outperform when the market praises central banks to cut rates.”

Ten-year government bond yields, a key barometer for mortgage rates, auto loans and credit cards, have risen nearly 80 basis points this year as the market adjusts to a regime of higher and longer interest rates. The current Fed Funds overnight lending rate from the Federal Reserve is 5.25%-5.50%.

After starting the year predicting at least six rate cuts, the market is now pricing in a 75% chance of just one rate cut, according to the CME Group’s widely followed FedWatch tracker, which derives its probabilities from the 30-day Fed Funds Futures. are trading. The central bank’s rate-setting Federal Open Market Committee began its two-day meeting on Tuesday.

Billionaire investor Warren Buffett has long emphasized the impact of interest rates on all investments. He says higher interest rates have a huge pull on asset values, reducing the present value of any future income.

Rising yields are reducing the appeal of risky investments, as shorter-term government bonds and longer-term government bonds offer solid returns and are a risk-free alternative to equities.

– CNBC’s Michael Bloom contributed reporting.

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