US Stocks Have 'Forgotten the War', Why Are US Treasuries Still Hesitating?

Oil price volatility continues to dominate risk pricing for macro assets, but the transmission paths between assets are diverging. Since the outbreak of the Iran war, stock sensitivity to oil prices has been declining, showing a positive "decoupling," while bond prices have remained largely synchronized with oil prices. This shift is reshaping the relative performance of stocks and bonds.

The S&P 500 Index just recorded its strongest 10-day gain since the April 2020 pandemic rebound, rising cumulatively by 9.8%. In stark contrast to the stock market's strength, US Treasury yields have only recovered a small fraction of their gains since the war began.

According to Zhui Feng Trading Desk, Deutsche Bank recently released a report stating that both stocks and bonds will remain highly sensitive to oil prices in the future, but at this stage, changes in investor weightings regarding growth, earnings, and fiscal spending expectations make it easier for stocks to "break free," while bonds remain tethered by inflation and supply pressures.

Pre-War Pricing Bias Limits Room for Treasury Yield Correction

One reason why the bond market struggles to repair as quickly as the stock market is that US Treasury yields already contained a pricing bias before the war broke out.

At the outset of the conflict, the 10-Year Treasury Yield was pushed to artificially low levels, driven by irrational market pessimism regarding the macro impact of artificial intelligence, and premature bets on a weakening US labor market and deflationary pressures.

At that time, market expectations for aggressive Federal Reserve rate cuts were fully priced in, but such expectations appear difficult to sustain in the current environment.

Subsequent employment data further undermined the rationale for rate cut expectations. The latest ADP employment data also signaled resilience in the labor market, a trend that had not been widely anticipated by the market prior to the war.

From a chart perspective, since the war began, the 10-Year US Treasury Yield and Brent Crude futures have maintained a nearly synchronous positive correlation: rising oil prices correspond with rising yields, indicating that inflation expectations are driving bond market pricing.

Nominal Earnings Growth Buffers Against Inflation, Providing Natural Cushion for Stocks

Unlike the bond market, the stock market possesses an inherent tolerance for moderate inflation increases, which forms the second logical support for the current stock-bond divergence.

Moderate inflation typically does not cause substantive harm to stocks because corporate earnings are nominal indicators that automatically expand as price levels rise.

S&P 500 earnings growth for the first quarter is expected to reach 19%, far exceeding average market expectations. This robust earnings outlook has already been gradually absorbed by the market, thereby providing a buffer for stocks against oil price shocks.

This mechanism does not exist in the bond market. Fixed-rate bond cash flows do not adjust for inflation. Rising oil prices drive higher inflation expectations, which directly increase discount rates, depress bond valuations, and create a price reaction opposite to that of stocks.

Fiscal Expansion Expectations Strengthen Stock-Bond Divergence

Expectations of expanded fiscal spending resulting from the Iran war constitute the third driver of divergence.

The war is likely to catalyze larger-scale fiscal spending, based on two logic layers: first, short-term government subsidy measures to protect consumers from energy price shocks; and second, medium-to-long term structural factors where the conflict will accelerate defense investment and energy independence construction across all parties, creating sustained fiscal expansion pressure.

Expanded fiscal spending implies an increase in government bond supply, exerting direct downward pressure on Treasury prices and pushing yields higher. For stocks, fiscal expansion is often interpreted as additional support for economic demand, particularly benefiting defense and energy-related sectors.

This divergence effect further widens the gap in how the stock and bond markets react to the same geopolitical shock.

Oil Prices Remain Key Variable; Sustainability of Divergence Trend Questionable

Although there is a clear divergence between stocks and bonds currently, investors must still remain mindful of risks.

Looking ahead, both the stock and bond markets will continue to remain highly sensitive to oil prices. The current relative strength of the stock market primarily reflects the market's re-pricing of the aforementioned three logics, rather than a permanent decoupling from oil prices.

Tick-by-tick correlation data between S&P 500 futures and Brent crude shows that while the negative correlation (i.e., rising oil prices corresponding to falling stock indices) has narrowed recently, it has not fundamentally reversed.

For investors, the current market landscape means that stocks retain relative downside protection in the short term, but if oil prices surge again or if employment and inflation data once again alter expectations for the Fed's policy path, the existing stock-bond divergence pattern will face renewed scrutiny.