BlackRock: The 80% correlation between oil prices and US Treasury yields this year broke down in October, with AI risk having overtaken geopolitical risk

BlackRock: The 80% correlation between oil prices and US Treasury yields this year broke down in October, with AI risk having overtaken geopolitical risk Oil prices rose over the past month, but in a departure from the 80% correlation that had held all year, US Treasury yields fell over the same period. What changed? Jeffrey Rosenberg, senior portfolio manager of the Systematic Alternatives ETF at BlackRock, Inc., the world's largest asset manager, recently said it was the decline in leading AI stocksthe Magnificent Seven. "Oil and Treasury yields had this amazing correlation, and in October it just stopped," he said. "That tells us something important. In the market's mind, GEO Group Inc political risk is secondary; AI risk is primary." A divergence after an FOMC meeting If there was one thing that was steady in 2026, it was that US Treasury yields would rise along with crude oil futures. Over the past month, that rule ended. In the view of Jeffrey Rosenberg, who works on the Systematic Alternatives ETF (IALT) at BlackRock, Inc., the world's largest asset manager, the breakdown of this trade has major implications for the market. "Oil and Treasury yields had this amazing correlation, and in October it just stopped," Rosenberg said. The relationship between oil prices and bond yields also came up at Fed Chair Kevin Warsh's FOMC press conference on WednesdayWarsh noted that the continued rise in crude oil futures was a factor the central bank must consider in fighting inflation. But Rosenberg said what Warsh did not discuss was "the most important conclusion." "Treasuries and oil had an 80% correlation this year," Rosenberg said, which is "insanely high" relative to normal levels. "We've basically been trading off oil, and with good reason." What happened? Rosenberg said looking at the deflated AI trade sums it up. As the market broke away from this oil-bond trading correlation in October, "that tells us something important," he said. "In the market's mind, GEO Group Inc political risk is secondary; AI risk is primary." Over the past monthmost painfully evident in Friday's Nasdaq plunge and in Alphabet Inc. Class C earlier this week posting its largest single-day drop in history, wiping out about $500 billion in market valuethe AI trade has undergone a pullback. Rosenberg said bond yields fell because the market equated weakness in the AI trade with broader weakness in the US economy. He also said last week's GDP report supported that judgment. "AI is everything, everywhere, all at once," he said. Growth on the investment side of the economy, and the wealth effect on the consumption side, are all AI, he said. "Third-quarter GDP was a blowout number, and it was all AI-related," Rosenberg said. He pointed to the increase in equipment investment and consumption that far exceeded expectations, both driven by the AI wealth effect; the latter is especially noteworthy given that real US incomes have been declining. Third-quarter business investment rose 12.7%, the largest increase since 2011 in 2026 excluding the pandemic, led by a 37% increase in information processing equipment investment. Industrial equipment investment rose nearly 25%, which, while not directly an AI trade, partly reflects data center spending. Warsh does not agree with his assessment of the economy. At the FOMC press conference, he said: "It's easy to attribute all the strength in this economy to this new wave of technology. In fact, if you look at the datareally from the last meeting to this onethe capex story is not just strong, not just strong, it's broadening. So if you want to tell a story that 'the strength we're seeing is only in a few narrow areas,' that story is much harder to tell now than it was a few quarters ago." Indeed, market breadtha measure of how many stocks in the S&P 500 are showing positive trading momentumimproved significantly in October after hitting a 2026 low at the end of September, alongside strength in defensive sectors such as healthcare and consumer staples. But Rosenberg said the overall conclusion the market drew in October was that any "wobble" in the AI trade would be seen as a wobble in the US growth outlook, and as disinflationary. And in a disinflationary environment, "there's only one thing that works as a hedge," he said, and that is "the thing everyone wants to hate... the long end of the Treasury curve." "That's the real lesson from last month's market action," he said. Despite that view, Rosenberg remains cautious about the claim that this dynamic makes bonds a safe choice. "The simplest answer is that this is not a return to normalnormal used to be bonds hedging stocks," he said. The reason is that the forces facing bonds are conflicting. Rising oil prices, and inflation that remains above target, will not go away as challenges to fixed-income assets and to the "effectiveness" of fixed income as a hedge. "Inflation is too high, which limits the Fed's ability to provide easing, and we haven't escaped that," he said. "But what we learned last month is that if it's big enoughif the AI trend turns against the macroeconomic and inflation trends, it can bring about a complete reversal in that direction, creating disinflation, and bonds could react the way they did in October." Still, he said investors should not bet that this trade will be one-way or without potential costs. Investors need to weigh the diversification benefits bonds may offer, based on October's action, against the scenario in which AI does not fracture the economy. And the longer the AI boom lasts, combined with broader US fiscal challenges, "bonds will come under pressure," he said. How to trade the AI hyperscalers' debt boom The AI trade itself is a very large part of the bond market, as was vividly demonstrated over the past weekon one side, Alphabet Inc. Class C's post-earnings decline, and on the other, Microsoft Corporation's return to the public bond market. "This was a surprise to the market. It hadn't come back for nearly a decade," Rosenberg said. As the tech giants' capex needs begin to exceed their free cash flow more frequently, the public bond market is absorbing an expected flood of issuance. "When the bond market, the public bond market looks at where all this supply is coming from... this is a huge marginal issuer, and it's coming more and more, again and again," he said. Hyperscalers are approaching the financing limits that bank loans and private credit markets can provide; Rosenberg emphasized that the $40 trillion to $60 trillion global bond market can absorb an estimated $4 trillion of AI debt over the next four years, but "the market's capacity is not unlimited." That demand will lead to lower prices and wider spreads, even though Microsoft Corporation's deal attracted substantial investor interest and was oversubscribed. Rosenberg said it is a good thing that more hyperscaler debt is being pushed into the public bond market, because it means more transparency in the form of bond prices and CDS spreads. Microsoft Corporation's (MSFT.US) credit default swap (CDS) spread is currently trading near a five-year high of about 55; by contrast, its CDS spread is worlds apart from Oracle Corporation's (ORCL.US), which is near 300. This offers investors another type of trading opportunity: for those who, given the US inflation environment and fiscal challenges, may not want to buy bonds outright but still want a hedge to bet on the AI boom. "It's that old tool from the great financial crisis," he said. "Short it. In the public credit market you can trade both ways, and in bank loans and private credit you can't. But once they start coming into the public market, you can." Rosenberg said Alphabet Inc. Class C's (GOOGL.US) 12% single-day drop is "not even on the chart historically." "So it's entering a different 'zip code'if you willa different range of market pricing, market volatility and market indigestion. It's not the end of the world, just a different world in the AI buildout," he said, adding that greater transparency in the public bond market gives investors more ability to trade "the emotional swing between fear and greed." Rosenberg believes what the CDS market is telling investors about the large hyperscalers is not that default probability is high, but that as all these companies try to obtain more debt financing, the ability of banks and financial intermediaries to find counterparties for these risks is becoming increasingly constrained. "Think about financial markets and these massive investment booms. They don't run in one direction. They go up in steps, then reset." But as far as the AI boom is concerned, so far there has only been "the positive part," Rosenberg said. "It's still an extremely positive story, but you'll see a bit of balance with AI pessimism."