Falling oil prices can't save US Treasury bonds! Goldman Sachs: The link between energy and interest rates is breaking down, and real yields are raising the bar for stock returns.

The drop in oil prices has not only failed to alleviate pressure on US Treasury bonds, but has also exposed the failure of the traditional link between energy and interest rates. Rich Privorotsky, head of Goldman Sachs' One-Delta trading desk, warned that the continued pressure on bond yields and widening credit spreads, while oil prices are falling, means that the market may be facing more than just short-term volatility, but a deeper structural change.

In his latest internal report, Privorotsky described a recent trading day as "the most unsettling day of cross-asset signals in this crisis": widening credit spreads, continued pressure on interest rates, and falling oil prices. Historically, declining energy prices have typically signaled easing inflationary pressures and helped alleviate stress in the bond market, but this transmission mechanism is now weakening.

Privorotsky argues that the problem may have shifted from the energy shock to fiscal financing itself. High real yields may be the "clearing price" that fiscally-led economies must pay to attract private capital and finance massive sovereign debt. Once the risk-free real yield is high enough, government bonds will begin competing with stocks for the same pool of private savings.

Energy prices fell, but this failed to alleviate interest rate pressures.

Privorotsky stated bluntly: "The link between energy and interest rates appears to be breaking down... If falling oil prices don't solve the problem, the situation will become even more complicated."

Although shipping through the Strait of Hormuz has largely recovered, the physical market remains tight, with price spreads and freight rates remaining high. The release of approximately 40 million barrels from strategic petroleum reserves can provide some buffer, but continued inventory declines mean that prices could still be more severely impacted should a new supply-demand imbalance emerge.

He believes that natural gas could become a more critical pressure valve for Europe. TTF prices have already fallen significantly, and if Qatar can increase its daily LNG supply by a small amount, the supply-demand balance in Europe could be further improved. However, the negotiation window is narrowing, and uncertainty remains.

In other words, falling energy prices are increasingly unable to play a role in "easing inflation, lowering yields, and improving financial conditions" on their own.

High real returns are raising the bar for stock returns.

Regarding the continued pressure on interest rates, Privorotsky cited technical factors such as the appreciation of the yen compressing global balance sheet capacity, triggering the unwinding of carry trades, and extreme interest rate volatility making market makers "unwilling or unable" to continue providing sufficient liquidity.

But in his view, these may only be symptoms; the deeper problem lies in the need for fiscal financing.

“At some point, this is simply the clearing price that fiscally-led economies must pay in order to attract enough private capital to finance massive sovereign debt.”

This has a more direct impact on the stock market. In recent years, low real returns have driven funds to migrate along the risk curve to assets such as stocks; if risk-free real returns remain high, this process may reverse.

When government bonds can provide sufficiently high real returns, stocks must offer even higher expected returns to attract private capital. In other words, the current pressure on the stock market is not only due to valuations being squeezed by rising interest rates, but also because the central level of risk-free asset returns is shifting upward, systematically raising the return threshold for stocks.

The resilience of the AI capital expenditure cycle continues to support the stock market, but Privorotsky says he will not take on higher positions until interest rates stabilize, credit spreads stop widening, and there is substantial progress in the energy situation.

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