NEW YORK: Deepening conflict in the Middle East has sent oil prices surging and Treasury yields climbing to levels that have equity investors on edge, raising fears that pain so far largely contained in the bond market could soon spill over into US stocks.
Oil prices spiked to US$100 a barrel for the first time since May last week, as the renewed hostilities revived investor worries over global supply disruptions from a near-halt in trade through the Strait of Hormuz.
Oil prices eased to just below US$100 last Friday.
Higher oil prices have intensified concerns that the US Federal Reserve (Fed) will need to raise rates to head off mounting inflation pressures, pushing the yield on benchmark US 10-year notes to 4.71%, its highest level since January 2025.
That has some investors worried about the near-term outlook for stocks, which so far have only started to feel the heat.
“I think investors did a pretty good job of shrugging off the initial phase of hostility, but the light at the end of the tunnel optimism appears to be dimming,” said Jack Ablin, chief investment officer at Cresset Capital.
“I kind of draw a line in the sand at four and three quarters on the 10-year,” Ablin said, noting that a climb in the 10-year yield above 4.75% would start to hurt stock valuations significantly.
That is because investors use interest rates to figure out what future company profits are worth today – higher rates make those future profits look less valuable now, diminishing the appeal of stocks.
Kristina Hooper, chief market strategist at Man Group, is also concerned about rising rates.
Rising rates “could very well become problematic soon”, she added.
“We have the 30-year yield at a place that it hasn’t been in years, and could easily go higher given concerns around inflation and given concerns around fiscal sustainability of the United States and as the war in the Middle East drags on,” said Hooper, who sees the 5% level on the 10-year yield as a critical barrier.
“That doesn’t mean that we won’t see pressure before then, but to me, that is a psychological level that can be quite impactful,” she said.
Equities have so far this year absorbed the shock of higher yields better than some investors had feared, with the S&P 500 scaling new highs as recently as early June.
Solid earnings growth and outlook, driven by artificial intelligence-related capital expenditure (capex), have kept investors optimistic even as resilient US economic data with strong retail sales and a solid labour market has helped allay earlier fears of stagflation.
“However, with them (yields) making new highs for the year, it’s something that will likely create at least some headwinds before too long,” Matthew Maley, chief market strategist at Miller Tabak + Co, said in a note.
Higher bond yields don’t just boost fixed income’s relative appeal for investment dollars – they also raise borrowing costs for consumers and companies, slowing the economy and weighing on equities.
As the market relies on hyperscalers to deliver on their ambitious capex plans, rising interest rates threaten to disrupt the equation.
“It’s going to look a little different to the chief executive officers of hyperscalers today...is it worth it for them to do the capex they were planning if they have to pay higher interest rates to finance it?” said Peter Graf, chief investment officer at Amova Asset Management Americas.
Still, Graf as well as others don’t see this as a signal to jettison stocks just yet.
For one, Graf sees expectations for Fed rate hikes as too aggressive.
Fed funds futures are pricing in about two 25-basis-point rate hikes by the end of the year.
“I don’t see why the Fed would respond hawkishly and fuel the fire at this point, given that the data that we’ve seen doesn’t look too bad from their perspective,” Graf said.
Even at these levels it is not immediately clear that earnings growth that has served as the backbone of the stock market rally is endangered.
“If you can’t really make a credible bear case that US$100 oil and US$4.50 gas is really going to destroy the earnings trajectory, then it’s hard to make a bear case on the equity market,” said Michael Purves, chief executive officer at Tallbacken Capital Advisers. — Reuters
