Stocks and Bonds Disagree on the Economy—Again. They Both Can’t Be Right.

Bonds are down, while stocks are up. Something has got to give. (TIMOTHY A. CLARY /AFP via Getty Images)

Stocks and Treasuries are sending conflicting signals about the economy.

The value of U.S. government bonds is down as the rate on the 10-year Treasury, a benchmark for the market, is up for a five consecutive days, or by 0.188 percentage points in July, to 4.415%. (Yields move in the opposite direction of bond prices.) The S&P 500 dropped Monday and Tuesday, but it is still up 0.3% for the month and needs to gain only 0.9% to mark another record.

The recent diverging performance comes against the backdrop of a larger trend that has been playing out over the past few months: Bond markets are not feeling great about the economy while the stock market is. These conflicting signals were pointed out by Apollo’s Chief Economist Torsten Slok in his note Tuesday morning.

Slok highlighted the stock market’s favoring of cyclical stocks over defensive stocks. Information technology, consumer discretionary, and industrials have been among the top performing S&P 500 sectors over the past three months, up 43%, 25%, and 28%, respectively. Utilities, consumer staples, and healthcare, sectors known for offering stable revenue irrespective of the economic climate, are among the worst performers, up 11%, 7.5%, and 2.2%, respectively. By pouring money into economically sensitive companies, investors are signaling that they are betting on a brighter economy.

Another way to evidence expectation of higher economic growth is by looking at market forecasts. Goldman Sachs, led by David Kostin, raised the firm’s S&P 500 year-end target to 6,600 from 6,100 late Monday. Likewise, Bank of America, led by Savita Subramanian, raised that bank’s year-end forecast to 6,300 from 5,600. Higher returns from stocks are typically expected in a higher economic growth environment.

In contrast, the bond market’s expectation for what the 1-year overnight interest rate will be, starting one year from today, has dropped. This rate is closely tied to expectations for the federal funds rate and stood at 3.5289% on May 14, the highest level in the second quarter. On Tuesday, it was at 3.2502%. The rate consistently decreased up until late June, reaching a low of 3.059% in the month; it then saw a small uptick in early July.

This forward rate suggests that the bond market has recently softened expectations for deep Federal Reserve interest-rate cuts, although it still sees deeper cuts than it did in May. Lower rates mean greater expectations of rate cuts from the Federal Reserve, which often signals that the economy needs a boost.

The 2-year yield—another way to evidence the bond market’s expectations of Fed rate cuts—has also moved lower from its mid-May highs. In May it reached a high of 4.05% but dropped to 3.72% by the end of June. It now stands at 3.907%.

The stocks-bonds disagreement on the economy’s trajectory isn’t new. In March, U.S. stocks felt the heat from the Trump administration’s tariff policies as the S&P 500 finished the month lower, but the bond market had traded in a tight range, showing hesitancy to call in weakness in the economy.

“Either the bond market is wrong, and rates must move higher due to accelerating growth. Or, equity markets are wrong, and stocks have to move lower because growth is slowing down,” Slok wrote, calling the markets “inconsistent.”

For those playing along at home and trying to decide whether to believe the stock or Treasury market, it’s helpful to keep in mind that grand revelations lie ahead. Next week’s June consumer price inflation data will disclose whether U.S. businesses are passing tariff costs along to the consumer, while the full schedule of tariffs is expected to become clear by Aug. 1. Together, these figures should clarify the trajectory of rate cuts and economic growth.

Write to Karishma Vanjani at karishma.vanjani@dowjones.com