While the 10-year yield is a “clear challenge” for stocks, Goldman says

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

Answer: 5% per 10-year Treasury yieldin accordance with Goldman Sachs. In a new 19-page paper using market data going back to the 1980s, the Wall Street firm said that once this threshold is reached, the correlation between bond and stock returns 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 stocks—the point at which the correlation with bond yields is no longer strongly positive,” the team wrote Goldman. strategists led by Peter Oppenheimer, chief global equity strategist.

The benchmark 10-year yield jumped 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 was another sign of the danger posed by persistent inflation, which the market believes will force the Federal Reserve to pause until later this year before it begins to consider rate cuts. 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 rise, leading to higher valuations.

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

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

After forecasting at least six interest rate cuts at the start of the year, the market is now pricing in a 75% chance of at least one rate cut, according to a widely followed CME Group report. FedWatch a tracker that calculates probabilities based on where 30-day fed funds futures are trading. The central bank’s 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, saying that higher rates have a huge gravitational effect on asset values, reducing the present value of any future earnings.

Rising yields reduce the attractiveness of risky assets, as shorter-dated Treasury bills and longer-term Treasury bills offer solid yields and are a risk-free alternative to stocks.

— CNBC’s Michael Bloom contributed reporting.