U.S. stocks have "forgotten the war," so why are U.S. bonds still entangled?

```

Oil price fluctuations are still dominating the risk pricing of macro assets, but the transmission paths between assets are diverging. Since the outbreak of the Iran war, the stock market’s sensitivity to oil prices has declined and even “decoupled” to the upside, while bonds have been moving almost in sync with oil prices. This change is reshaping the relative performance of stocks and bonds.

The S&P 500 Index just recorded a 9.8% gain over 10 trading days, the strongest 10-day increase since the pandemic rebound in April 2020. In contrast to the stock market's strength, US Treasury yields have only retraced a small portion of their rise since the outbreak of war.

According to Wind Chaser Trading Desk, Deutsche Bank’s recent report points out that both stocks and bonds will remain highly sensitive to oil prices in the future, but at this stage, changes in investor expectations for growth, profits, and fiscal expenditure mean stocks are more likely to “break free from constraints,” while bonds remain dragged by inflation and supply pressures.

Pre-war Pricing Misalignment, Limited Room for Treasury Yield Pullback

The bond market is unable to recover as quickly as stocks, and one of the root causes is that Treasury yields were already mispriced before the war broke out.

At the onset of the war, the 10-year US Treasury yield was pushed to an overly low level, driven by factors such as the market’s irrationally pessimistic outlook on the macro impact of artificial intelligence and premature bets on a weakening US labor market and deflationary pressure.

At that time, expectations for aggressive Fed rate cuts had already been fully priced in, but those expectations now look unlikely to be supported.

Subsequent employment data further undermined the legitimacy of rate cut expectations. The latest ADP employment data likewise signals resilience in the labor market, a trend not widely anticipated before the outbreak of war.

As shown in the chart, since the outbreak of the war, the 10-year US Treasury yield and Brent crude futures have been almost perfectly positively correlated, with rising oil prices accompanied by rising yields—showing that inflation expectations are dominating bond market pricing.

Profit Nominal Growth Effect Offsets Inflation, Providing Stocks a Natural Cushion

Unlike bonds, the equity market has an inherent tolerance for a certain degree of inflation, which is the second logical support for the current divergence between stocks and bonds.

Moderate inflation usually does not materially harm stocks, because corporate profits are nominal indicators that can automatically expand with rising price levels.

S&P 500 Index first-quarter earnings growth is expected to reach 19%, far exceeding the market average forecast. This strong profit outlook has already been gradually absorbed by the market, thereby giving stocks a buffer against oil price shocks.

This mechanism does not exist in the bond market. The cash flows from fixed-rate bonds are not adjusted for inflation, and higher inflation expectations driven by rising oil prices directly push up the discount rate and depress bond values, causing a price reaction that is the exact opposite of equities.

Fiscal Expansion Expectations Strengthen Stock-Bond Divergence

Expectations of increased fiscal spending due to the Iran war constitute the third driving factor for divergence.

The war is likely to generate larger-scale fiscal expenditures, with logic on two levels: in the short term, governments introduce subsidy policies to protect consumers from energy price shocks; in the medium and long term, structural factors include the war prompting all sides to accelerate defense spending and energy independence building, creating sustained fiscal expansion pressure.

An increase in fiscal expenditures means greater government bond issuance, which directly suppresses Treasury prices and pushes yields higher. For stocks, fiscal expansion is often interpreted as an extra boost to economic demand—especially favoring defense and energy sectors.

This divergence further widens the different reactions of the stock and bond markets to the same geopolitical shock.

Oil Prices Remain the Key Variable, Sustainability of Divergence in Doubt

Although stocks and bonds are clearly diverging at present, investors still need to be cautious about risks.

Looking ahead, both stocks and bonds will remain highly sensitive to oil prices. The current relative strength of the equity market mainly reflects a repricing around the above three logics, rather than a permanent decoupling from oil prices.

High-frequency correlation data between S&P 500 futures and Brent crude oil shows that, although the negative correlation (i.e., oil price rise corresponds to stock index drop) has narrowed somewhat recently, it still has not fundamentally reversed.

For investors, the current market structure means that stocks still have relative short-term resilience, but if oil prices surge again, or if employment and inflation data once again change expectations for Fed policy, the current stock-bond divergence pattern will be retested.

~~~~~~~~~~~~~~~~~~~~~~~~

The above exciting content is from Wind Chaser Trading Desk.

For a more detailed interpretation, including real-time commentary, frontline research and more, please join the Wind Chaser Trading Desk Annual Membership

Risk Disclosure and DisclaimerThe market carries risks, and investments should be made cautiously. This article does not constitute personal investment advice and does not take into account the individual investment objectives, financial situation, or needs of any particular user. Users should consider whether any opinions, views, or conclusions in this article are appropriate to their individual circumstances. All investments made accordingly are at their own risk. ```