Rising Tension Between Bonds and Equities
Wolfe Research economist Stephanie Roth has adopted a more cautious stance toward risk assets, arguing that the growing disconnect between climbing bond yields and resilient equity markets may become increasingly difficult to maintain.
In a client note published over the weekend, Roth said Wolfe Research has also revised its Federal Reserve outlook, now expecting all anticipated interest rate cuts to be delayed until the second half of 2027.
According to Roth, “something eventually has to give,” as bond markets increasingly reflect expectations for persistently elevated inflation while equity markets continue to price in a much more favorable economic backdrop.
Wolfe Outlines Three Possible Paths to Lower Yields
Wolfe Research identified three scenarios that could potentially bring yields lower.
Those include weaker-than-expected economic growth, a broader equity market decline severe enough to trigger a risk-off environment, or President Donald Trump deciding to de-escalate the conflict with Iran after reaching his political and economic pain threshold.
However, the firm cautioned that none of those outcomes would likely be particularly supportive for financial markets.
The research house believes the third scenario has probably not yet materialized, while the first two outcomes would inherently weigh on risk assets.
“Our bias is that rates likely continue repricing higher until either growth weakens, equities begin to crack more materially, or Trump reaches his pain threshold and takes a deal with Iran,” Roth commented.
Inflation Risks Continue to Pressure Markets
Roth noted that inflation forecasts continue to rise following a series of upside surprises, increasingly driven by the Iran conflict as well as strong artificial intelligence-related spending and memory demand.
As a result, Wolfe believes the Federal Reserve remains “a long way from being able to calm markets.”
Global Bond Selloff Accelerated Last Week
The recent bond market selloff intensified on Friday after stronger-than-expected producer price data from Japan sparked renewed inflation concerns.
The move later spread to the United Kingdom, where investors also faced concerns tied to renewed government instability, before extending into broader global fixed-income markets.
U.S. Treasury yields climbed by as much as 12 basis points during the session, with several maturities reaching recent highs.
Fed Officials Increasingly Focused on Inflation
Roth said Federal Reserve officials have recently become more vocal about inflation risks.
“Fed officials appeared increasingly concerned about the outlook. Among voting members, the mix skews slightly dovish, but even then the messaging has converged to inflation upside risks,” stated Roth. “Regional presidents have led the way in voicing their inflation worries, but a few governors, including Michael Barr and Chris Waller, have begun striking a similar tone.”