Investing.com — The global bond market has been in the spotlight over the last two weeks amid a protracted selloff in government debt, leading to a significant rise in yields, as traders fret over the inflationary shock emerging from surging sparked by the Middle East conflict.
Market participants across the world over the last two weeks have bumped up their expectations of interest rate hikes by central banks in order to combat the boost to inflation from spiking oil prices. Concerns over the long-term economic effects of the biggest oil supply disruption in history caused by the shuttering of the Strait of Hormuz has made investors averse to government-backed debt.
Several benchmark instruments around the globe have scaled notable “highest ever” milestones: surged to levels not seen since September 1996, while the hit its highest level on record. Over in the United Kingdom, hit levels not seen since 1998. At home, hit its highest in over a year, while climbed to levels not seen since 2007.
Goldman Sachs analysts noted this week that equities were seeing an effect from the surge in yields, as a historically underlying relationship between the two shaped markets.
“While equities remain near all-time highs and interest rates elevated, the underlying relationship (on a daily or weekly basis) has rarely been as important—or as negative—as it is today,” Goldman Sachs analysts led by Guillaume Jaisson said in a research note on Friday.
The analysts highlighted five reasons for why equities are so sensitive to bond markets: the level at which yields are, the speed with which they have advanced, the relative valuation of stocks, late-cycle market dynamics, and economic growth expectations.
“Higher yields increase fragility. In the U.S., 10y yields at 4.6% are within a range (4.5–5.0%) that has historically coincided with more negative equity–rate correlations. Similarly in Europe, with above 3%, rates are approaching a comparable threshold – also, given Europe started from a lower base, the ’tipping point’ may be reached earlier than historically,” the analysts said.
Meanwhile, the latest advance in the U.S. 10-year yield has seen it gain by around 25 basis points over the past month. Goldman Sachs noted that that was well above a historical trend in which equities underperform when bond yields move more than 1.5 standard deviation over a month – or currently about 20 basis points.
At the same time, high equity valuations provide less buffer against higher rates, as they reduce the market’s ability to absorb increases in discount rates, the brokerage said. Additionally, the Goldman analysts noted that market sensitivity to rates typically tend be the highest in the later stages of the economic cycle.
“Today’s environment—characterized by persistent inflation, resilient growth, elevated valuations, and structural optimism around themes such as AI—bears many hallmarks of a late-cycle phase. In such periods, markets are more vulnerable to policy or rate shocks,” the analysts said.
“Our Asset Allocation Team has shown that since the onset of the Middle East conflict, markets have largely interpreted developments as an inflation shock rather than a (negative) growth shock. As a result, equities have become negatively correlated with short-term inflation,” they said.
“By contrast, the correlation with long-term inflation remains positive, as it is still tied to growth expectations,” they added.