Wolfe Research economist Stephanie Roth has taken a more guarded view on risk assets, arguing that the current divergence between climbing bond yields and relatively steady equities is unsustainable. In a weekend client note, Roth moved the firm's Federal Reserve timing call, deferring all anticipated rate cuts to the second half of 2027.
Roth wrote that "something eventually has to give," describing how rates are beginning to price in a higher-for-longer inflation environment while equity markets still appear to be anticipating a much milder outcome. That imbalance, she warned, creates a growing strain on financial markets.
The research team at Wolfe set out three conceivable ways yields could ease: one, growth disappoints; two, equities weaken enough to provoke a broader risk-off episode; or three, President Trump reaches a political or economic "pain threshold" and de-escalates the conflict with Iran. The firm noted that none of these pathways are particularly constructive for risk assets.
Wolfe judges that the third option - meaningful de-escalation with Iran - likely has not been realised yet, while the first two alternatives by definition would exert negative pressure on risk assets. "Our bias is that rates likely continue repricing higher until either growth weakens, equities begin to crack more materially, or Trump reaches his pain threshold and takes a deal with Iran," Roth commented.
Inflation upside surprises are appearing more persistently, Wolfe said, with the Iran conflict and AI-related capital expenditure and memory demand contributing to upward pressure on inflation forecasts. Those trends, Roth argued, leave the Federal Reserve "a long way from being able to calm markets."
The acceleration in the global bond selloff that intensified on Friday began after hotter-than-expected producer price data in Japan, then spread to the United Kingdom amid renewed government instability concerns, and thereafter broadened across markets. U.S. Treasury yields rose by as much as 12 basis points, with several maturities hitting recent highs.
Roth further observed that Fed officials appear increasingly worried about the outlook. She wrote that while the balance of voting members tilts slightly dovish, messaging across officials has converged toward concerns about upside inflation risks. "Regional presidents have led the way in voicing their inflation worries, but a few governors, including Michael Barr and Chris Waller, have begun striking a similar tone," she said.
Wolfe's revised outlook and the reasoning behind it underscore a broader tension for investors: higher bond yields that reflect more persistent inflation and policy caution, set against equity valuations shaped by a more sanguine economic and inflation trajectory. The firm's assessment suggests that until one of the three yield-reducing scenarios occurs, markets may have to reconcile the growing divergence between fixed income and equities.
Clear summary
Stephanie Roth at Wolfe Research has grown more cautious on risk assets, delaying expected Fed rate cuts to the second half of 2027. The firm highlights three limited pathways to lower yields - disappointing growth, a significant equity selloff, or de-escalation in Iran - and notes persistent inflation upside tied to geopolitical tensions and AI-driven demand as a factor keeping the Fed on edge.
Key points
- Wolfe Research has pushed all expected Federal Reserve rate cuts into the second half of 2027.
- Three scenarios could bring down yields - disappointing growth, a broader risk-off in equities, or de-escalation with Iran - but none are particularly beneficial for risk assets.
- Persistent inflation upside, attributed to the Iran conflict and AI-related capex and memory demand, is complicating the Fed's ability to reassure markets.
Risks and uncertainties
- Growth disappointment - If economic growth weakens, this would likely be negative for equities and other risk assets.
- Equity market deterioration - A more pronounced selloff in equities could trigger a broader risk-off move that would be damaging for risk assets.
- Geopolitical escalation - Continued conflict involving Iran is contributing to upside inflation surprises and increases uncertainty for inflation and interest rate expectations.