Bonds may soon cease to be the biggest threat to equities

As has been the pattern for much of this year, a sharp rise in government bond yields in September heaped yet more downward pressure on stock markets, with the S&P 500 reaching its lowest level since late 2020 earlier this week. Since central banks in most advanced economies seem to have turned even more hawkish recently, we now think that long-dated bond yields in most developed markets (DMs) will end this year near their current levels rather than fall back further, as we had previously envisaged. But we still expect significant declines in yields next year, as central banks eventually pivot towards looser policy.

Despite this, we do not think that stock markets are out of the woods just yet. The prospect of even tighter monetary policy in the near term points to a sharper economic slowdown than is currently factored into our forecasts for risky assets. While the relationship is far from perfect, growth in the US economy falling below its secular trend would point to the profits of US companies dipping below trend too. (See Chart 1.) We think that, as the more challenging outlook for both the economy and corporate earnings is discounted, stock markets could continue to grind lower, even if government bond yields do not rise any further.