The relationship between bond yields and equities has turned negative again, says LPL Financial
Storm clouds are brewing over U.S. government bonds
Bond yields are rising amid a flood of government and corporate supply, and alongside sticky inflation. The U.S. just sold 30-year debt at its highest borrowing cost since 2001.
Stock markets seemingly care not a jot. As the Treasury long bond yield BX:TMUBMUSD30Y traded near a multiyear peak, the S&P 500 SPX on Thursday registered its 27th record closing high of 2026. Even the usually more interest rate-sensitive Russell 2000 index RUT of small caps hit a record.
However, LPL Financial chief equity strategist Jeff Buchbinder implies that higher bond yields actually may have been constraining the stock market's ebullience of late, and that a likely pullback in yields should provide additional propulsion for equities.
In commentary published Thursday, Buchbinder explains that the stock market's relationship with bonds is fluid. Equities can happily rise alongside climbing bond yields (meaning falling bond prices) if the reason for the increase in rates is faster economic growth that most likely will boost corporate profits.
But if bond yields are rising primarily because of fears about increased debt supply or burgeoning inflation, then those elevated rates, particularly if the rate of ascent is quick, can reach a threshold that spills into equity market selling pressure, according to Buchbinder.
"The 10-year [Treasury] yield has remained uncomfortably high as sporadic flare-ups in kinetic activity and unanswered questions around energy production and shipping disruptions in the Middle East have led markets to increase their expectations of a Federal Reserve rate hike," he says.
Such a dynamic has led stocks and rates to move in opposite directions in the past, and it's come back into play at times again this year.
As the chart below shows, when the 10-year Treasury yield BX:TMUBMUSD10Y rises in a sustained move above the 4.3% range, the three-month weekly correlation with the S&P 500 flips negative, suggesting that stocks have struggled above this level, Buchbinder contends.
Source: LPL Financial
"When the 10-year yield has entered this range, market concerns of higher rates potentially hurting the economy and the equity market via higher borrowing costs impairing demand for big-ticket purchases, weighing on stock valuations, and increasing the cost of capital (especially for the more debt-laden small cap space) begin to dampen risk appetite until upward pressure on yields ebbs," he says.
So, the important question for investors is whether yields will continue to rise apace, risking a negative reaction from equities.
On that, Buchbinder is optimistic that a key cause of rising rates, higher energy costs, will be ameliorated in coming months.
"Negotiations in the Middle East are ongoing, and all parties still seem interested in eventually reaching a diplomatic resolution," he says. "While global economic impacts may change depending on how long that takes, once a deal is reached crude prices and Treasury yields are likely to come off recent highs, and we continue to expect the 10-year yield to finish the year between 4.00% and 4.50%."
And as stocks' correlation with rates is currently negative, Buchbinder says "we would expect stocks to feel some support if upward pressure on Treasury yields eases - aligning with our expectations for modest equity market gains over the second half."
Source: LPL Financial
In terms of how different sectors will react to bond moves, he notes that higher yields could weigh more on materials, real estate, and developed-market stocks, as they have been the most negatively correlated assets to 10-year Treasury yields over the last year. The opposite is true if bond yields fall, of course.
"On the other side of the coin, and to little surprise, energy companies and crude oil futures could be relative outperformers in the event of a breakout higher in yields, as they have displayed the highest correlation to yields," says Buchbinder.
The markets
U.S. stock-index futures (ES00) (YM00) (NQ00) are mixed as Treasury yields BX:TMUBMUSD10Y rise. The dollar index DXY is lower, as oil futures (CL.1) climb and gold futures (GC00) trade around $4,402 an ounce.
Key asset performance Last 5d 1m YTD 1y S&P 500 7798.99 1.15% 3.52% 13.93% 20.57% Nasdaq Composite 26,803.03 1.73% 3.56% 15.32% 23.46% 10-year Treasury 4.664 1.30 11.40 49.20 34.30 Gold 4402.4 0.02% 9.43% 1.62% 30.18% Oil 82.51 7.04% 0.90% 43.72% 30.68% Data: MarketWatch. Treasury yields change expressed in basis points
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