U.S. Stocks, Bonds Rise on Divergent Economic Views

Recently, the U.S. stock and bond markets have both experienced significant gains, but this apparent harmony masks a deeper divergence in economic outlook. The bond market is pricing in a slowdown in employment, while the stock market is betting on an acceleration in economic growth.

On September 8, U.S. Treasury yields fell across the board, with long-term bonds showing the most significant decline. This pushed the 30-year Treasury yield into negative territory for the year, and the 10-year yield hit a five-month low. Meanwhile, the Nasdaq index briefly touched a new all-time high before retreating but still closed higher, with tech giants providing the main support. This dual rise in stocks and bonds comes ahead of key economic data releases, including revised employment figures, inflation reports, and the Federal Reserve's meeting, with market activity relatively subdued.

The divergence in the "stock and bond rally" is not based on a unified optimistic outlook. The bond market's narrative is more straightforward, focusing on signs of a cooling U.S. economy. The decline in Treasury yields, particularly in long-term yields, reflects investors' growing belief that economic slowdown will prompt the Federal Reserve to adopt a more accommodative monetary policy. The 5-year U.S. Treasury yield's movement is highly correlated with the U.S. Labor Market Surprise Index, indicating that when employment data falls short of expectations, bond yields tend to decline. Currently, the bond market is primarily focused on the slowing domestic labor market and is pricing in a more dovish Federal Reserve.

Market expectations for rate cuts are heating up, providing support for bond prices. As investors prepare for the upcoming employment data revisions and inflation data, the bond market's pricing logic clearly points to a "bad news is good news" scenario: the weaker the economic data, the higher the likelihood and magnitude of a Fed rate cut.

In contrast, the stock market appears to be looking beyond current economic turbulence, envisioning a brighter future. Despite the U.S. stock market struggling near the flatline on September 8, the resilience of large-cap tech stocks and some cyclical stocks suggests that investors are not panicking over signs of economic slowdown. The stock market is "anticipating a cyclical acceleration," with part of this confidence stemming from supportive monetary and fiscal policies. Data shows that the mid-cap index's movement is correlated with the U.S. Survey Data and Business Cycle Surprise Index, indicating that the stock market is more sensitive to the long-term economic outlook.

Long-term investors are actively buying tech stocks, while funds have been flowing into non-tech cyclical stocks over the past few months. This indicates that investors are voting with their wallets, betting on an economic recovery driven by policy stimulus.

This divergence is not limited to the stock and bond markets. On September 8, gold prices surged above $3,600 per ounce, hitting a new all-time high, while the U.S. dollar index weakened to its lowest closing level since July 25.

These cross-asset movements further highlight the uncertainty and multiple bets investors are making ahead of key economic milestones. In the next two weeks, the U.S. will release heavyweight data, including CPI figures, revised non-farm payrolls, and the Federal Reserve's rate decision.

Despite the seemingly contradictory narratives in the stock and bond markets, a harmonizing perspective is offered. The market is currently pricing in approximately 1.7% GDP growth for the next four quarters, which is not far from economists' forecast of 1.5%. Additionally, the rate market is pricing in five rate cuts from September this year to June next year, which aligns perfectly with economists' expectations.

From this perspective, the pricing in the stock and bond markets may not be entirely contradictory: the bond market is pricing in near-term economic slowdown and necessary policy easing, while the stock market is pricing in the ultimate outcome of policy easing successfully guiding the economy towards recovery.

However, risks remain. The market has already priced in significant rate cut expectations, and if the stock market genuinely starts to worry about growth prospects, its downside potential could be opened up. Conversely, if the labor market unexpectedly strengthens, already high bond prices could face a correction risk.