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

Traders work on the floor at the New York Stock Exchange (NYSE) in New York City, U.S., April 29, 2024. 

Brendan Mcdermid | Reuters

The volatility in the bond market has had equity investors on their toes for months, but at what point will rising yields spoil stocks’ 2024 rally?

The answer is 5% on the 10-year Treasury yield, according to Goldman Sachs. In a new 19-page paper using market data since the 1980s, the Wall Street firm said when that threshold is reached, the correlation between bond yields and stocks turns negative.

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

The benchmark 10-year yield jumped 5 basis points Tuesday to 4.67% after data showed employee compensation costs increased more than expected to start the year. It marked yet another danger sign about persistent inflation, which the market thinks will keep the Federal Reserve on hold until later this year before it starts to consider cutting rates. A basis point equals one-hundredth of a percentage point.

Goldman said investors are currently in the “optimism phase” of the cycle, where confidence — and complacency — grow, pushing valuations higher.

“Equity valuations are higher and the cycle is more mature so equity markets are very sensitive to moves in bond yields,” Goldman said. “They underperform with yields moving higher around news of overheating and higher inflation, while they outperform when the market prices Central Banks to cut interest rates.”

The 10-year Treasury yield, a key barometer for mortgage rates, auto loans and credit cards, has risen almost 80 basis points this year as the market adjusts to a higher-for-longer rate regime. The current rate on the Federal Reserve’s fed funds for overnight lending is 5.25%-5.50%.

After starting the year forecasting at least six reductions in interest rates, the market is now pricing in a 75% chance of just one rate cut, according to the CME Group’s widely followed FedWatch tracker that derives its probabilities from where 30-day fed funds futures are trading. The central bank’s rate-setting Federal Open Market Committee began its two-day meeting Tuesday.

Billionaire investor Warren Buffett has long stressed the impact of interest rates on all investments, saying higher rates exert a huge gravitational pull on asset values, lowering the present value of any future earnings.

Rising yields dent the appeal of risk assets as shorter-dated Treasury bills and longer-dated Treasury notes offer solid yields and a risk-free alternative to stocks.

— CNBC’s Michael Bloom contributed reporting.

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