Key Highlights

  • Crude is racing back towards triple digits and long-dated bond yields sit at their highest in nearly two decades, yet
  • Two of the market's most reliable warning lights are flashing at once.
  • Start with energy.
  • The bond move is arguably more consequential.

Crude is racing back towards triple digits and long-dated bond yields sit at their highest in nearly two decades, yet share markets have barely flinched. That disconnect is what worries the sceptics.

Two of the market's most reliable warning lights are flashing at once. Oil is climbing back towards $US100 a barrel and long-term US government bond yields have surged to their highest levels since before the global financial crisis. What unnerves some strategists is not the moves themselves, but the Equity market's apparent indifference to them. As The Australian Financial Review put it in its 7 September edition, the "risk of a correction is high" after an oil surge and a bond meltdown, even as the ASX and Wall Street "have barely budged."

The two pressures building

Start with energy. Brent Crude was trading around $US95 a barrel in early September, according to Forbes Advisor, with the AFR reporting it near $US98 as the benchmark raced back towards triple digits. Higher oil feeds directly into Inflation and squeezes household budgets, complicating the path for central banks that had been leaning towards easier policy.

The bond move is arguably more consequential. The US 30-year Treasury Yield pushed above 5.2 per cent in early September, its highest since 2007, and entered the month on its worst stretch since 2006, according to Bloomberg and Trading Economics data. The 10-year yield sat near 4.79 per cent. Rising long-term yields lift the discount rate applied to future company earnings, which in theory should weigh on the equities that have run hardest.

Yet the reaction has been muted. The S&P/ASX 200 stood around 8,943 points on 7 September, off an August record near 9,297 but down only about 3 per cent over the month, according to Trading Economics. With US markets closed for Labor Day, local traders faced a session with limited offshore direction.

Why the calm may be deceptive

The bull case for the equanimity is straightforward. Commodity strength, particularly in copper, is lifting resource Earnings and supporting the materials-heavy Australian index. A firmer economy can justify higher bond yields without necessarily derailing shares, and Australia's second-quarter GDP grew 0.4 per cent in the quarter and 2.1 per cent over the year, according to FXStreet, hardly recessionary.

The bear case is that markets are pricing perfection. When yields climb because of persistent inflation and heavy government borrowing rather than robust growth, the usual "good news" interpretation breaks down. Oil above $US95 adds a fresh inflationary impulse just as bond markets are demanding more compensation to hold long-dated debt. If equity investors have not adjusted, the argument runs, the eventual repricing could be abrupt.

History offers mixed guidance. Sharp bond selloffs have sometimes preceded equity corrections and sometimes simply reflected a strengthening economy. The distinction matters, and it is rarely clear in real time. The 1994 bond rout, for instance, rattled markets without triggering a lasting equity slump, whereas other yield spikes have marked turning points.

What investors will be watching

Several signals could tip the balance. A decisive break of $US100 in Brent would sharpen the inflation debate. Any sign that the bond selloff is accelerating rather than stabilising would test the resilience of richly valued sectors. And the Reserve Bank's tone, with markets leaning towards a more hawkish stance and the Australian dollar at a multi-month high around US72.2 cents, will shape the local backdrop.

None of this makes a correction inevitable. Markets can absorb higher yields and dearer oil for extended periods, particularly when corporate earnings hold up. But the gap between deteriorating macro conditions and steady share prices is the kind of tension that tends to resolve, one way or the other. For now, investors are being asked to decide whether the calm reflects confidence or complacency.