This is where the 10-year yield is an ‘obvious problem’ for stocks, says Goldman

Bond market volatility has kept stock investors on their toes for months, but when will rising yields spoil the stock rally in 2024?

The answer is 5% on the 10-year Treasury yield, according to Goldman Sachs. In a new 19-page paper using market data from the 1980s, the Wall Street firm says that when this threshold is reached, the correlation between bond yields and stocks becomes negative.

“While there is no ‘magic number,’ historically, bond yields around 5% are when higher yields become a clear problem for stocks – that’s when the correlation with bond yields is no longer decidedly positive,” a Goldman team wrote. strategists led by Peter Oppenheimer, Chief Global Equity Strategist.

The benchmark 10-year yield jumped 5 basis points Tuesday to 4.67% after data showed employee compensation costs jumped more than expected for the start of the year. This is another danger sign for persistent inflation, which the market expects will keep the Federal Reserve on hold until the end of the year before it begins considering cutting rates .

Goldman said investors are currently in the “optimism phase” of the cycle, where confidence – and complacency – is increasing, pushing valuations higher.

“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 following news of overheating and higher inflation, while they outperform when the market prices central banks to cut interest rates.”

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

After starting the year forecasting at least six interest rate cuts, the market now puts the chance of a single rate cut at 75%, according to the CME Group’s widely followed tracker FedWatch, which derives its probabilities from ‘where 30 day fed funds futures trade. The central bank’s Federal Interest Rate Setting Committee began its two-day meeting on Tuesday.

Warren Buffett has long highlighted the impact of interest rates on all investments, arguing that higher rates exert a huge gravitational pull on asset values, lowering the present value of any future profits.

Rising yields diminish the appeal of risky assets, as shorter-dated Treasuries and longer-dated Treasuries offer solid returns and a risk-free alternative to stocks.

— CNBC’s Michael Bloom contributed reporting.