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Since eclipsing the symbolic 4,000 level a couple of weeks ago, the benchmark S&P 500 Index has gained a further ~3% this month, and is now nearly 10% higher since the start of the year. At the same time, the bond market has taken something of a break: the 10-year Treasury yield has been broadly stable since mid-March. Nonetheless, economists at Capital Economics are sticking, for now, to their end-2021 forecast of 4,200 for the S&P 500 Index because they anticipate that the sell-off in the bond market will resume in due course and that this will slow down stock market gains.

Higher yields will slow the stock market’s rally

“The stabilisation in the bond market has probably helped add fuel to the stock market rally. But we expect the sell-off in bonds to resume before long. And we think this will hold back further gains in the stock market as well.”

“We expect further rises in bond yields to be mostly driven by higher real yields. With a rapid economic recovery on the way, and the Fed committed to keeping policy accommodative until inflation is above target over a sustained period, we think there is scope for long-dated real yields to rise further as investors increasingly factor in that the Fed will have to tighten the real stance of monetary policy more further down the line.”

“Admittedly, a good part of the positive economic news – such as fiscal stimulus and the effective vaccine rollout – looks to be now discounted in financial markets. But there is still considerable uncertainty about the pace of reopening, and we think that the economic recovery may still prove even more rapid than many are anticipating. So we suspect the rise in real yields still has room to run, capping further gains in stock prices.”