Bond yields and inflation are back in the driving seat for stocks, ahead of PPI release

Bonds are boring (sorry), and I think we’d all like to discuss inflation less.

Unfortunately, both are relevant for stocks again because the relationship between what the US government’s debt is doing and how stock prices move has flipped in a big way.

In fact, this is the most extreme yields-stocks relationship of this entire market cycle.

As noted by Christian Mueller-Glissmann at Goldman Sachs:

“Equity correlations to both bond yields and oil have moved further into negative territory… [and] sharply higher yields due to rising inflation tend to weigh on equities. Equities have been able to digest higher rates so far due to micro tailwinds from AI capex and strong earnings.”

This is the empirical version of the “AI and record profit margins are Atlas holding up the world” meme; but if Atlas is starting to wobble, which is up for debate, it’s only because inflation is tickling him.

For much of the post-global financial crisis era, bond yields and stocks have been positively correlated, primarily because when yields have moved higher, it’s typically been because expectations of growth — or at the very least expectations of earnings growth, rather than GDP growth — have been improving.

With this in mind, yesterday’s CPI print had the potential to be explosive. The blowup never came, however, and it ended up being pretty benign, with core CPI a touch cooler than anticipated, while headline CPI was in line with estimates from Wall Street economists.

Today, we get another inflation update, and this time it’s PPI: the Producer Price Index, which last month came in hotter than expected. Analysts expect PPI to come in 6.4% up year on year, or a 0.7% increase month on month.

Up is down, down is up

It’s worth remembering that though a negative correlation between yields and stocks sounds scary (it’s got the word negative in it, for one thing), it isn’t necessarily — it’s similarly likely that a soft print, or a downward move in yields or oil, sends stocks ripping higher.

So, how do you invest in this new normal?

It’s super simple: have a view on whether rates go up or down, then why they go up and down, and, finally, be right.

Once you have that bit nailed... energy is the only one of the S&P 500 sectors that has had a positive correlation to yields (+0.39) over the past three months, per Bloomberg data. (Mueller-Glissmann at Goldman Sachs kind of spoiled that for you, but it’s also hopefully not surprising, given that the source of our inflationary concerns have mostly been oil-related).

PPI is out at 8:30 a.m. ET.