(Bloomberg) -- Any year-end rally in European equities faces an additional challenge from the rise in longer-term Treasury yields, according to Goldman Sachs Group Inc. strategists.

While the curve between the US two- and 10-year bonds is still inverted, the gap has shrunk to the smallest this year on bets that central banks won’t increase policy rates further. However, the Goldman team including Lilia Peytavin and Peter Oppenheimer said the advance in longer-term bond yields doesn’t necessarily reflect better growth expectations.

That’s in contrast to previous instances that occurred after the global financial crisis, where the steepening in the curve was a sign of lower deflation risks and was typically a boost to stocks, they wrote in a note.

Moreover, “the level from which rates are rising is already quite high, and a further increase in interest rates would likely weigh on equities and cyclicals,” the strategists said. Finally, equity valuations “do not look very attractive,” with the risk premium at a 15-year low. “This means that there appears to be much less cushion for equities to digest higher rates,” they said.

Goldman’s Oppenheimer has remained bearish this year after correctly predicting the stock slump of 2022.

European equities are in their third month of declines and on the brink of erasing their 2023 gains as US bond yields march higher on worries about persistently hawkish central banks. The yield on the 10-year Treasury hit 5% for the first time since 2007 on Monday. Geopolitical threats arising from the Israel-Hamas war have also dented risk appetite in recent weeks. 

With the Stoxx 600 benchmark now testing major support as well as oversold technical levels, the focus will be on the European Central Bank’s meeting later this week.

Separately, a Citigroup Inc. note showed investors added to their short positions in Euro Stoxx 50 futures last week.

--With assistance from Michael Msika.

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