Goldman says the 10-year bond yield is an “obvious problem” for stocks

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

The answer is 5% 10-year Treasury bond yieldAccording to Goldman Sachs. In a new 19-page paper that uses market data from the 1980s, the Wall Street firm said that when that limit is reached, the relationship between bond and stock yields becomes negative.

“While there is no ‘magic number’, bond yields at around 5% historically are when high yields become an obvious problem for stocks – and this is the point at which the correlation with bond yields is no longer decisively positive,” the Goldman Sachs team wrote. . The strategists are led by Peter Oppenheimer, chief global equity strategist.

The benchmark 10-year yield jumped 5 basis points on Tuesday to 4.67% after data showed employee compensation costs rose more than expected to start the year. It was another red flag about persistent inflation, which the market believes will keep the Fed on hold until later this year before it begins to consider cutting interest rates. A 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, pushing 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 yields rise on 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 gauge of mortgage rates, auto loans and credit cards, rose about 80 basis points this year as the market adjusts to a regime of higher interest rates for a longer period. The current Federal Reserve funds rate for overnight lending is 5.25%-5.50%.

After starting the year predicting at least six rate cuts, the market is now placing a 75% probability on just one rate cut, according to CME Group's FedWatch tracker, which derives its odds in terms of which 30-day federal funds futures contracts are trading. The Federal Open Market Committee, which sets the central bank's interest rates, began its two-day meeting on Tuesday.

Billionaire investor Warren Buffett has long emphasized the impact of interest rates on all investments, saying that rising interest rates exert an enormous impact on asset values, lowering the present value of any future earnings.

Rising yields weaken the appeal of risky assets, as shorter-dated Treasuries and longer-dated Treasuries provide strong returns and a risk-free alternative to stocks.

— CNBC's Michael Bloom contributed reporting.