Stocks and bonds expectations "clash": the stock market bets on slowing growth, while the bond market is on high alert for inflation surges

Ask AI · Why does the divergence between bonds and stocks stem from investor sentiment differences?

Under the impact of the Iran war, European and American financial markets are playing out a rare internal contest. The bond market is pricing inflation risks at multi-year highs, believing that a rate hike cycle is imminent, while the stock market’s trend suggests that economic slowdown will suppress interest rates or even trigger rate cuts.

In Europe, the interest rate swap market has already priced in three rate hikes by the European Central Bank this year. The 10-year German benchmark government bond yield reached a 15-year high on March 27, while major institutional investors like BlackRock are still betting on further declines in bonds.

However, the logic behind European stock market pricing is entirely different: the Stoxx Europe 600 index’s price-to-earnings ratio remains around 15 times expected earnings, well above the average of the past twenty years, with analysts forecasting corporate earnings to grow by 11% by 2027.

In the US, the S&P 500 index’s cyclically adjusted price-to-earnings ratio has recently remained above 38, in a range considered historically high over the past 150 years. The divergence between stocks and bonds has already spread to the two major core markets globally, forcing investors to face a directional choice.

The bond market expects an aggressive rate hike cycle to begin

The sharp reaction in the bond market directly reflects historical scenarios. According to Bloomberg, Amélie Derambure, senior multi-asset portfolio manager at AXA Investment Managers in Paris, said that the fixed income market is pricing inflation impacts similar to those triggered four years ago by Russia’s invasion of Ukraine.

“I think the price reaction in the fixed income market is particularly intense,” she said. “The stock market remains uncertain about the economic consequences of this conflict, but the bond market is already pricing based on the 2022 scenario.”

At that time, energy prices surged, pushing Eurozone inflation to record highs, forcing the European Central Bank to initiate the most aggressive rate hike cycle in history.

The current Iran situation has again raised concerns over energy supply, compounded by Europe’s already high inflation base, prompting bond investors to take defensive actions first. Institutions like BlackRock are betting on yields rising further, resonating with the market’s expectation of three rate hikes in interest rate swaps.

However, the stock market believes: economic deterioration will limit the room for rate hikes

The logic of the stock market is a mirror image of the bond market. Investors generally believe that, if the geopolitical conflict persists, the substantial drag on economic activity will prevent central banks from tightening policies significantly, making rate hike expectations ultimately unlikely to materialize.

Karen Georges, equity fund manager at Ecofi in Paris, describes this divergence as “market schizophrenia,” stating:

“We clearly do not expect two rate hikes, let alone three—considering how prolonged crises will impact economic activity, if growth is substantially hit, a rate cut could even occur before the end of the year.”

Analysts’ forecasts of 11% profit growth for European companies by 2027 are also based on assumptions of a mild economic environment and loose financing conditions, which fundamentally conflict with the aggressive rate hike path priced in by the bond market. If the economy slows down, profits disappoint, and central bank easing expectations fall short, the currently high stock valuations will face significant downward pressure.

US investors continue to rely on the “geopolitical shocks will eventually pass” empirical approach

US stock investors continue to follow a repeatedly validated empirical strategy: treat geopolitical shocks as short-term disturbances and hold positions through turbulent periods.

According to Bloomberg, George Nadda, portfolio manager at Altana Wealth in London, said: “Recent history teaches investors to see geopolitical disruptions as temporary because their actual economic impact is relatively limited.”

Historical data supports this view—during the Gulf War and Iraq War, oil prices surged sharply, but the stock market rose within six months of the conflicts’ outbreak; similarly, during the initial phase of the Ukraine war in 2022 and the “Liberation Day” tariff shocks in April 2025.

Under this logic, US sell-side analysts are generally reluctant to cut earnings forecasts, with EPS estimates trending upward ahead of the April earnings season. Investors also continue to hold optimistic expectations of strong US economic growth before the conflict erupted.

Two assets, two different genes

Behind the divergence between stocks and bonds, reflect two fundamentally different ways of thinking among asset investors.

Kevin Thozet, member of the Carmignac Investment Committee in Paris, said that the gap between stocks and bonds can partly be explained by their respective fundamental stances:

“By definition, stock investors are optimists, focusing on future profits; while bond investors are entirely focused on protecting themselves from inflation erosion.”

The ultimate decider of this divergence will be the direction of economic data and central bank policies.

If inflationary pressures continue to rise as the bond market fears, stock valuations will face dual pressures from rising interest rates and declining earnings; if growth, as the stock market expects, becomes the main contradiction, then the aggressive pricing in bonds will gradually correct. Currently, both markets are waiting for the other to be proven wrong.