Don't just focus on the absolute level! Goldman Sachs: The speed of U.S. Treasury yield changes is also a "killer" for U.S. stocks.

The continued rise in US Treasury yields is reshaping the cross-asset landscape, and Goldman Sachs believes investors should not only focus on the absolute level of yields—the speed of change and the underlying drivers are also key variables in determining whether the stock market can absorb rate pressure.

According to "Chasing the Wind Trading Desk," last week, US inflation data unexpectedly rose, economic activity remained robust, global bonds suffered sell-offs, and a reflationary macro environment combined with spillover effects from UK and Japanese markets pushed long-end Treasury yields to multi-decade highs. Goldman Sachs data show that the weekly increase in US 10-year yield exceeded 2 standard deviations last week, and stock-bond correlation dropped to its most negative level since the late 1990s, posing a severe test for balanced investment portfolios facing simultaneous declines in both stocks and bonds.

In response, Goldman Sachs maintains a neutral rating for bonds over 3 and 12 months in its asset allocation and notes that the "equity down/rates up" dual binary option hedging strategy holds high appeal for balanced portfolios, especially as an overlay hedging tool.

Stock-bond correlation drops to most negative in nearly 30 years

Goldman's latest GOAL Kickstart report points out that the two-month rolling correlation between US stocks and the US 10-year Treasury yield has dropped to its most negative level since the late 1990s.

This shift is not accidental. The report thinks that since the Middle East war and the subsequent energy price shock, the market has regarded inflation rather than growth as the primary source of macro shocks. The relative volatility between Goldman Sachs' "global growth" principal component (PC1) and "monetary policy" principal component (PC2) has decreased, happening concurrently with the negative movement in stock-bond yield correlation.

Meanwhile, the correlation between the S&P 500 and short-end inflation pricing (directly affected by energy price increases) has sharply turned negative, as has the correlation with real yields of the 10-year; while the correlation with forward inflation remains positive. This differentiation indicates that the market is currently highly sensitive to rate increases driven by inflation.

The "source" of yield increases determines stock market reaction

Goldman Sachs emphasizes that the reaction of the stock market to rising yields largely depends on the source, speed, and starting point of rate changes.

Regarding the source, increases in yields driven by improved growth are typically better absorbed by the stock market, as optimistic growth sentiment can buffer the pressure from rising discount rates. In an inflation-dominated rate environment, stock-bond yield correlation turns negative. Goldman notes that since April, growth expectations supporting stock prices have mostly come from micro factors (such as AI investments) rather than macro catalysts, which is a departure from the past.

Regarding speed, even if the source of rising rates is relatively mild, the pace of change itself can become a resistance. Historical data show that when yields rise sharply and disorderly, the stock market often struggles to absorb it. Previous bond sell-offs had been relatively orderly, but last week the US 10-year yield increased by more than 2 standard deviations in a single week, reminding investors not to prematurely downplay the risk of a right tail in rates.

Absolute levels are of reference value, but not the strongest signal

In terms of absolute yield levels, Goldman Sachs believes the impact exists but is relatively weaker. Historically, when the US 10-year nominal yield breaks through 5% or the real yield exceeds 2% to 2.5%, it is often associated with more negative stock-bond correlation.

Goldman thinks that a more valuable indicator is the difference between the 10-year real yield and the consensus forecast for long-term real GDP growth—which is currently 2.1%. When real yields are above long-term growth expectations, it means monetary policy is tight, posing a more challenging macro environment for stocks.

Based on current valuations, the US 10-year yield is at 4.60%, only at the 2nd percentile in the past 10 years, showing bonds are more attractive from a risk premium perspective. Goldman forecasts the US 10-year yield to fall to 4.25%, 4.10%, and 4.07% over the next 3 months, 6 months, and 12 months, respectively.

Hedging strategy: "Equity down/rates up" dual binaries are attractive

Facing the risk of simultaneous declines in both stocks and bonds, Goldman Sachs recommends investors consider "equity down/rates up" dual binary options as a hedging tool, particularly suited as an overlay strategy for balanced portfolios.

Goldman Sachs data shows that in scenarios where the S&P 500 drops more than 5% combined with a rise in the 10-year real yield, this type of hybrid option provides high value for money compared to current prices, ranking near the top among various hedging tools.

Notably, although the implied correlation between stock-bond yields has declined since February, implied correlation remains high compared to realized correlation, suggesting that hedging demand against further rate shocks has not been fully released and pricing for related hedging tools still has room.

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The above content is from Chasing the Wind Trading Desk.

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