The best case to 'stem the bleeding' in bonds won't be good for stocks

Treasury yields have surged to near 16-year highs, weighing on stocks and crushing sentiment across financial markets.

And there might be only one way to end the pain for investors in the usually sleepy bond market: a washout in stocks.

"We do not see a clear catalyst to stem the bleeding," Barclays strategist Ajay Rajadhyaksha wrote in a note to clients on Wednesday, adding there is no "magic level" that will automatically draw investors back to bonds and stop the sell-off.

"In the short term, we can think of one scenario where bonds rally materially," Rajadhyaksha added. "If risk assets fall sharply in the coming weeks, bonds will likely benefit."

As Treasury yields have surged, Wall Street has struggled to find a clear catalyst for what is pressuring fixed income markets. In turn, this makes what might end the current pain for investors equally tough to locate.

Still, the best case for fixed income investors is likely more pain in the equity markets.

After a massive rally to begin the year, strategists including SoFi's Liz Young believe stocks need to fall further to bring the S&P 500 down to a fair valuation.

"I don't see a next leg higher on the imminent horizon," Young recently told Yahoo Finance when asked what's next for the S&P 500. "We are in a capital constrained environment. This pullback has been rational, I don't think it's over, and multiples need to come down even further for the equity market to look rational."

A potential trigger for yields falling could also be a softening economy, according to Wall Street strategists.

A minor preview of this trade played out on Wednesday as yields came off recent highs and stocks rallied following an ADP employment report that was much weaker than Wall Street had expected. Friday's jobs report could further put this thinking to the test.

"Right now, the biggest argument to buy Treasuries is the growth outlook," eToro US investment analyst Callie Cox told Yahoo Finance.

"The US economy seems to be on solid footing but there's a lot of pressure on it and the Fed is hell bent on getting inflation down. So, against that backdrop you could make an argument for the economy slowing, or if you're worried about cracks forming underneath the surface, then you'd probably want to look at safer assets again."

But two key issues also stand in the way of this thesis.

For starters, the 2023 economy has consistently come in stronger than expected. And even as some signs of cooling in the labor market are formulating, clear consistent weak data hasn't been the trend.

"Bond bulls waiting for weak data to come to their rescue are likely, we think, to be disappointed," Barclays' Rajadhyaksha wrote. "Eventually, near-8% mortgage rates and a US long bond at almost 5% might weaken the economy considerably. But not quickly enough to help the current bond market."

And, as Cox points out, the prospect of an economic downturn bringing down yields isn't the best argument for stocks to rise higher.

"I call it the pain trade for a reason," Cox said. "Rising yields are largely inexplicable right now but they can have real consequences for the economy and there's no guarantee that they come down anytime soon."

Josh is a reporter for Yahoo Finance.

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