Oil price volatility continues to dominate the risk pricing of macro assets, but the transmission pathways between assets are diverging. Since the outbreak of the Iran war, the sensitivity of stocks to oil prices has declined, showing a somewhat positive decoupling, while bond prices have remained almost synchronized with oil price movements. This shift is reshaping the relative performance of stocks and bonds.
The S&P 500 index recently recorded a cumulative gain of 9.8% over ten trading days, marking its strongest ten-day rally since the pandemic recovery in April 2020. In contrast to the stock market's strength, U.S. Treasury yields have only recovered a small portion of their increase since the war began.
According to tracking data from trading desks, a recent Deutsche Bank report noted that both stocks and bonds will likely remain highly sensitive to oil prices in the future. However, at this stage, shifts in investor expectations regarding growth, earnings, and fiscal spending have made it easier for equities to "break free from constraints," while bonds remain tethered by inflation and supply pressures.
**Pre-war Pricing Discrepancies Limit Room for Treasury Yield Retreat**
One reason bond markets have been unable to rebound as swiftly as stocks is that Treasury yields were already mispriced before the conflict began. At the start of the war, the 10-year U.S. Treasury yield was pushed to unsustainably low levels, driven by factors such as irrational pessimism regarding the macroeconomic impact of artificial intelligence and premature bets on a weakening U.S. labor market and deflationary pressures. At that time, market expectations for aggressive Federal Reserve rate cuts were already fully priced in, an outlook that now appears difficult to sustain. Subsequently released employment data further undermined the rationale for those rate cut expectations. The latest ADP employment report also signaled labor market resilience, a trend not widely anticipated before the war began. Chart analysis shows that since the war started, the 10-year U.S. Treasury yield has maintained an almost synchronous positive correlation with Brent crude futures, with rising oil prices corresponding to higher yields, indicating that inflation expectations are driving bond market pricing.
**Nominal Earnings Growth Provides a Natural Buffer for Stocks Against Inflation**
Unlike the bond market, the stock market possesses an inherent tolerance for a certain degree of rising inflation, forming the second logical pillar supporting the current stock-bond divergence. Moderate inflation typically does not cause substantial damage to stocks because corporate earnings are a nominal metric, inherently scaling up with increases in the price level. First-quarter earnings growth for the S&P 500 is projected to reach 19%, significantly surpassing average market expectations. This robust earnings outlook has been gradually absorbed by the market, thereby providing equities with a buffer against oil price shocks. This mechanism is absent in the bond market. The cash flows from fixed-rate bonds do not adjust with inflation. Rising inflation expectations driven by higher oil prices directly push up discount rates, depressing bond valuations and creating a price reaction opposite to that seen in stocks.
**Fiscal Expansion Expectations Widen the Stock-Bond Divide**
Expectations for expanded fiscal spending resulting from the Iran war constitute the third driver of this divergence. The conflict is likely to spur larger government expenditures, based on a two-tiered logic: firstly, short-term government subsidies to shield consumers from energy price impacts; and secondly, medium-to-long-term structural factors, where the war accelerates increased defense investments and energy independence initiatives, creating persistent fiscal expansion pressure. Increased fiscal spending implies a larger supply of government bonds, directly suppressing Treasury prices and pushing yields higher. For stocks, fiscal expansion is often interpreted as additional support for economic demand, particularly benefiting sectors related to defense and energy. This divergent effect further widens the differing reactions of stock and bond markets to the same geopolitical shock.
**Oil Prices Remain a Key Variable; Sustainability of Divergence is Questionable**
Despite the current clear divergence between stocks and bonds, investors must remain cautious of risks. Looking ahead, both equity and bond markets are expected to stay highly sensitive to oil prices. The current relative strength in stocks primarily reflects a market repricing based on the three aforementioned logics, rather than a permanent decoupling from oil. Data on the tick-by-tick correlation between S&P 500 futures and Brent crude shows that while the negative correlation (where rising oil prices correspond to falling stock indices) has narrowed recently, it has not fundamentally reversed. For investors, the current market structure suggests that stocks may maintain relative resilience in the short term. However, should oil prices experience another significant surge, or should employment and inflation data again alter expectations for the Fed's policy path, the existing stock-bond divergence will face a renewed test.