A further big rise in the 10-year Treasury yield this year would lead to a dramatic decline in the stock market, according to Goldman Sachs.
"While our base case looks for a gradual rise in the 10-year rate to 3.25% by year-end, we next stress test the outlook for a larger increase to 4.5%," economist Daan Struyven wrote in a note to clients Saturday. "A rise in rates to 4.5% by year-end would cause a 20-25% decline in equity prices."
Struyven said such a sudden increase in bond yields "would cause a sharp slowdown but no recession." He estimates the higher interest rates in such a scenario would detract 0.5 percentage points of GDP growth from the U.S. economy this year and lower growth by 1 percentage point in 2019.
A sharp mover higher in rates to those levels is not the firm's base prediction, but this analysis is useful for investors to keep in mind if rates continue to rise higher than Wall Street and Goldman currently expects.
The S&P 500 fell officially into correction territory in early February, down more than 10 percent from its record reached in January. The benchmark pared some of those losses in recent weeks.
Traders blamed the sell-off on increasing worries about rising inflation and the prospect for a faster pace of interest rate hikes by the Federal Reserve. The U.S. 10-year Treasury yield, which moves inversely to bond prices, had climbed to four-year high of 2.95 percent earlier in the month after the strong January jobs report.
Despite the move, Goldman Sachs isn't too concerned over the recent move bond yields.
"Treasury yields have risen quickly over the last two quarters, with the 10-year yield up 70bp in 5 months," Struyven wrote. "We expect the recent rise in rates to be well absorbed for two reasons. First, our analysis shows that the increase in rates over the last two quarters mostly reflects positive growth news. Second, the overall growth impulse from financial conditions remains positive, as equity prices have surged and the dollar has weakened over the last year."