Stocks and bonds at odds: Stock market bets on slowing growth, while bond market braces against surging inflation.

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Under the shock of the Iran war, European and American financial markets are witnessing a rare internal contest. The bond market is pricing inflation risk at a multi-year high, anticipating an imminent rate hike cycle, while the stock market’s performance suggests that economic slowdown will suppress interest rates or even trigger rate cuts.

In Europe, the interest rate swap market has already priced in three rate hikes by the European Central Bank this year. On March 27, the German 10-year benchmark bund yield hit a 15-year high, and major institutional investors such as BlackRock continue to bet on further declines in bond prices.

However, the pricing logic of the European stock market is completely different: The price-to-earnings ratio of STOXX Europe 600 constituent stocks is still about 15 times expected earnings, much higher than the average of the past 20 years, and analysts further predict that corporate profits will grow by 11% by 2027.

As for the US stock market, the S&P 500’s cyclically adjusted price-to-earnings ratio recently remains above 38, at a historically high range within more than 150 years of data. The divergence between stocks and bonds has already spread to the world’s two core markets, forcing investors to make directional choices.

The Bond Market Expects the Start of an Aggressive Rate Hike Cycle

The dramatic reaction of the bond market stems from a direct mapping to historical scenarios. According to Bloomberg, Amélie Derambure, Senior Multi-Asset Portfolio Manager at AXA Investment Managers in Paris, says that the fixed-income market is pricing the inflationary impact of this conflict similarly to the aftermath of Russia’s invasion of Ukraine four years ago.

"I think the price response in the fixed income market is particularly intense," she said. "The stock market still has uncertainties about the economic consequences of this conflict, but the bond market is already referencing the 2022 scenario in its pricing."

At that time, soaring energy prices pushed Eurozone inflation to a record high, forcing the European Central Bank to embark on the most aggressive rate hike cycle in its history.

This time, the situation in Iran has again triggered concerns over energy supply, compounded by Europe’s already high inflation base, leading bond investors to take the defensive response first. Institutions such as BlackRock are betting on further rises in yields, resonating with rate swap market’s expectations of three hikes.

The Stock Market Believes: Deteriorating Growth Will Contain Rate Hike Room

The logic of the stock market forms a mirror image to the bond market. Investors generally believe that if geopolitics persist, substantial drag on economic activity will render central banks unable to tighten policy significantly, and rate hike expectations will ultimately be unrealized.

Karen Georges, Equity Fund Manager at Ecofi in Paris, calls this divergence "market schizophrenia." She says:

"We clearly don’t expect even two rate hikes, let alone three—considering how a protracted crisis would hit economic activity, if there is substantial impact on growth, one could even imagine a rate cut before the end of the year."

Analysts’ forecasts for 11% profit growth in European companies by 2027 are also based on assumptions of a mild economic environment and loose financing conditions, fundamentally contradicting the aggressive rate hike path priced in by the bond market. Once economic growth slows, corporate earnings disappoint, and the central bank’s easing expectations fail, the currently high stock valuations will face significant downward pressure.

US Stock Investors Persist With "Geopolitical Shocks Will Eventually Pass" Empiricism

US equity investors, meanwhile, stick to a repeatedly tested empirical strategy: treat geopolitical shocks as temporary disturbances and hold positions through turbulent periods.

According to Bloomberg, George Nadda, Portfolio Manager at Altana Wealth in London, said, “Recent history teaches investors to view geopolitical disruptions as transient phenomena, since such events have relatively limited impact on the economy.”

Historical data supports this view—during the Gulf War and Iraq War, oil prices surged, but the stock market posted gains within six months of the conflicts' outbreaks; the same was true at the early stages of the Ukraine war in 2022 and the "Liberation Day" tariff shock in April 2025.

Under this logic, US sell-side analysts generally refrain from lowering earnings forecasts, with per-share earnings estimates actually trending upward ahead of April’s earnings season. Investors also maintained their pre-shock optimism about robust US economic growth.

Two Asset Classes, Two Natures

Behind the stock-bond divergence lies a fundamental difference in the mindsets of two types of asset investors.

Kevin Thozet, member of the investment committee at Carmignac in Paris, says that the gap between equities and bonds can in part be explained by their underlying postures:

"By definition, equity investors are optimists, focused on future profits, while bond investors are entirely focused on protecting themselves from inflation erosion."

The final arbiter of this divergence will be economic data and the direction of central bank policy.

If inflationary pressures persist as the bond market fears, equity valuations will face downward pressure from both interest rate and earnings sides; if, as the stock market expects, growth becomes the main problem, the aggressive bond pricing will gradually be corrected. Currently, both markets are waiting for the other to be proven wrong.

Risk Warning and DisclaimerThe market involves risks and investment needs caution. This article does not constitute personal investment advice and does not take into account the particular investment objectives, financial situations, or needs of individual users. Users must consider whether any opinions, viewpoints, or conclusions in this article are in line with their own specific circumstances. Investment based on this article is at your own risk. ```