The Oil-Yield Link Has Broken. BlackRock Says AI Is Now the Market’s Main Risk.

A long-standing correlation treated as an iron law of global financial markets has suddenly unraveled. Jeffrey Rosenberg, senior portfolio manager of BlackRock’s Systematic Alternative Investment ETF (IALT), highlights that the strong correlation between crude oil futures and US Treasury yields—which peaked at 80% earlier this year—came to an abrupt halt in October. The breakdown of this previously reliable trading logic carries significant, far-reaching implications for financial markets.

Speaking on CNBC’s “ETF Edge,” Rosenberg noted, “Oil and Treasury yields had maintained an astonishing correlation, but in October that linkage stopped.” He attributes this shift to the cooling of the AI trade, arguing that in the market’s view, geopolitical risk has been overtaken by AI risk as the primary driver.

This perspective stands in stark contrast to comments from Federal Reserve Chair Kevin Warsh. At his post-meeting press conference, Warsh emphasized that persistently rising crude oil futures prices remain a critical factor the central bank must consider in its fight against inflation. However, Rosenberg argues that the most crucial takeaway from the current environment is that markets are repricing around artificial intelligence, rather than oil.

October’s market action strongly supports this view. The Nasdaq experienced a broad selloff last Friday, following Google’s historic single-day decline earlier in the week, which wiped out $500 billion in market value. Rosenberg described a 12% single-day drop as “simply off the charts” historically, asserting that market pricing and volatility have entered an entirely new regime.

Treasury yields declined as the market interpreted weaknesses in the AI trade as a signal of broader softening in the US economy. Last week’s US GDP report reinforced this narrative. “The third-quarter GDP data were extremely strong, but it was all thanks to AI,” Rosenberg remarked. He pointed out that both equipment investment growth and stronger-than-expected consumption were driven by the wealth effect generated by AI. Given that Americans’ real incomes continue to decline, the upside surprise in consumption appears even more unusual.

Data reveals that US corporate investment surged 12.7% in the third quarter, marking the largest increase since 2011 outside of the pandemic period. This growth included a 37% rise in information-processing equipment investment and a nearly 25% increase in industrial equipment investment. While the latter is not purely AI-related, it partly reflects massive capital spending on data-center construction.

Warsh, however, does not subscribe to the narrative that economic growth rests entirely on a new technology wave. During the press conference, he stated that the capital-spending story is not only strong but broadening, making it more difficult than it was a few quarters ago to argue that current economic strength is confined to a narrow segment of the economy.

Rosenberg notes that the core conclusion markets drew in October is that any hint of trouble in the AI trade is perceived as a threat to US growth prospects, directly triggering disinflation expectations. In such a disinflationary environment, “only one asset works as a hedge”—long-dated Treasuries, ironically the very asset investors had previously been avoiding.

However, he cautions against concluding that bonds have fully returned to their safe-haven role. “Put simply, the market has not returned to the old seesaw norm between stocks and bonds,” he explains. The bond market remains pulled by two opposing forces: rising oil prices and persistently above-target inflation have not disappeared, continuing to undermine the effectiveness of fixed-income assets as a hedge.

“Inflation is still too high, which ties the Fed’s hands on easing, and we have not emerged from that predicament,” he explained. “However, last month’s market action also reminded us that if the shock is violent enough—if the AI trend reverses and feeds back into the macroeconomy and inflation—it could trigger a full reversal in market direction.”

He warns investors against assuming this trade will play out in a single direction or without costs. The longer the AI boom persists, especially when combined with the United States’ daunting fiscal deficit challenges, the greater the test for the bond market.

The AI trade itself has become a pivotal force in the bond market. Over the past week, both the stock selloff triggered by Google’s earnings and Microsoft’s return to the public bond market have demonstrated this reality. Rosenberg noted that Microsoft had not appeared in the public bond market for nearly a decade, and its sudden return caught the market by surprise.

As the capital-spending needs of tech giants increasingly outstrip their free cash flows, the public bond market must prepare for a wave of new issuance. Rosenberg explains that the financing scale of hyperscale cloud providers is gradually approaching the capacity limits of bank loans and private credit markets. While the $40 trillion to $60 trillion global bond market can absorb an estimated $4 trillion in AI-related debt over the next four years, “the market’s absorption capacity is ultimately not unlimited.”

Massive financing needs will inevitably push bond prices lower and credit spreads wider. Nevertheless, more hyperscaler debt entering the public market is not necessarily a negative development, as increased issuance and credit default swap (CDS) spreads will bring greater transparency. Microsoft’s CDS spread currently hovers near a five-year high of about 55 basis points, while Oracle’s is close to 300 basis points—a vast disparity between the two.

Rosenberg argues that the CDS market is not signaling that large tech companies face high default risk. Instead, it suggests that as these companies seek more debt financing, banks and financial intermediaries are increasingly limited in their ability to find counterparties to absorb these risks.

“Think back to the great investment booms in financial market history—they never run in a straight line, but climb in steps, then go through a shakeout and reset,” he concluded. The AI boom so far has shown only its soaring side; “this remains a grand narrative with enormous potential—it’s just that with AI pessimism surfacing, the market has finally regained a measure of balance.”

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