Nonfarm payrolls surprised sharply to the upside for October, yet Friday’s print served largely as a sideshow to a dramatic week of market volatility. In early October, the dominant narrative was that rates were unlikely to move meaningfully lower as seemingly limitless corporate borrowing to fund AI capex competed for capital. Since then, weakness across the neocloud complex and the election results have shifted attention toward the risks surrounding the viability and financing of the AI buildout. Credit markets have responded in kind, with spreads widening and both investment grade and high yield approaching their widest levels of the year.
As AI sentiment cools and the Iran war risk premium fades, inflation expectations have fallen alongside broader risk sentiment. The one-year inflation swap is now pricing inflation near 2% this time next year, reducing the need for additional Fed tightening at the margin. While the market currently prices one hike in December and another next year, even that path remains highly dependent on inflation developments, which for now are moving in a more favorable direction.
Treasury yields are now roughly 50 basis points below their early-October highs. The move has occurred alongside weaker risk sentiment and wider credit spreads, suggesting markets may be beginning to price slower growth rather than persistent inflation and capital-supply pressures.
The recent period could mark an important inflection point in the relationship between rates and risk assets. Bonds and equities have generally been positively correlated as inflation has remained the dominant risk, with inflation surprises pushing yields higher while weighing on equities. Markets are not necessarily pricing a slowdown as the base case, but they are assigning a greater probability to slower-growth outcomes in the distribution of future scenarios given the uncertainty around AI funding and future inflation. A shift in the balance of risks could be enough to turn the bond-equity correlation negative again, with Treasuries increasingly benefiting as risk assets come under pressure.
