The climb in U.S. Treasury yields shows no sign of easing. Inflation worries stemming from the war in the Middle East, combined with unexpectedly strong U.S. economic growth, have pushed the 10-year Treasury yield to its highest level in 19 years. The move has spread to Europe, Japan and other major markets, raising tension across global finance. Yet even after yields crossed 5% — once seen as a danger line — equities have held up better than expected, drawing attention to why. Some argue that expectations for artificial intelligence growth are absorbing the shock of higher rates, while others counter that the concentration in AI stocks is masking cracks elsewhere.
The 10-year Treasury yield rose as high as 5.27% intraday on the 28th, its highest since June 2007, according to the Financial Times. The two-year yield hit 4.96%, a 28-month high, and the 30-year yield climbed to 5.55%. The selloff in U.S. Treasurys spilled into other major bond markets, sending Britain's 10-year gilt yield to 5.44%, its highest since 2007, while French and Italian yields also reached multi-year highs.
Despite the continued rise in market interest rates, the stock market's reaction has been calmer than anticipated. The S&P 500 is down only about 1.5% from the record high it set in mid-August. Although the 10-year yield has moved well above 5%, long regarded as a psychological resistance level, there has been no large-scale outflow from equities or dumping of risk assets.
Market participants point to the strength of the U.S. economy as the reason. Solid growth is pushing market rates higher while also serving as a buffer that allows the economy to withstand the impact of those higher rates.
Analysts say much of the recent rise in yields has been driven by higher real rates reflecting economic growth, rather than by inflation fears. According to the U.S. online outlet Axios, the nominal yield on the five-year Treasury note rose 72 basis points over the past month, of which 66 basis points came from higher real yields. The increase in inflation expectations, calculated as the gap between nominal and real yields, was just 6 basis points. That data sits somewhat at odds with the view that inflation worries driven by surging oil prices are pushing Treasury yields higher. Axios noted that U.S. jobless claims remain at their lowest level in 57 years and that large-scale corporate investment centered on AI is lifting real rates as the economy stays strong.
Corporate earnings forecasts are also improving quickly. An analysis by asset manager State Street of FactSet and S&P data showed that as of the 14th of this month, the projected growth rate for S&P 500 companies' earnings per share this year had risen above 30%. That is nearly double the forecast of about 15% at the start of the year, reached in just a few months. The prevailing view is that AI-related investment is the key driver lifting corporate results.
Some analysts go further, arguing that AI has ushered in a new phase and that yields in the 5% range are not the threshold that would break the stock market. Bank of America said the 10-year Treasury yield would have to approach 7% before equity investors turn and the market suffers a meaningful blow. The last time the 10-year yield reached the 7% range was July 1996.
Others worry, however, that gains in AI-linked Big Tech shares are creating the illusion that the broader market is healthy. According to Goldman Sachs, the median decline from 52-week highs among S&P 500 constituents is 16%, a level similar to the bubble era of the early 2000s. The index sits just 1% below its record high, yet half of its members have fallen 16% or more from their 52-week peaks. Large AI-related stocks with heavy weightings are holding up the index, obscuring the correction underway in the rest of the market.
Another problem is the vicious cycle in which rising bond yields erode the appeal of equities. The S&P 500's earnings yield is about 5.3%, the inverse of a 12-month forward price-to-earnings ratio of 19. That is roughly in line with the 10-year Treasury yield, which has climbed above 5.2%. The forward P/E ratio itself has fallen from 23 a year earlier. With the gap narrowing sharply between stocks, which carry risk, and Treasurys, which are treated as risk-free, equities look less attractive.
Experts are split on bond investing. Rick Rieder, chief investment officer for global fixed income at BlackRock, the world's largest asset manager, told The Wall Street Journal that his funds are generating returns above 7% with a duration of three years, adding that he had waited 40 years for such an opportunity. With high returns now available even on relatively short-dated bonds, the incentive to hold stocks and take on risk may be smaller than before.
Ray Dalio, founder of Bridgewater Associates, the world's largest hedge fund, took the opposite view, noting that the United States is spending more than $1 trillion a year on interest payments alone and has begun crowding out other spending. His concern is that if the U.S. budget deficit widens and Treasury issuance keeps growing, the market may demand still higher yields even with a strong economy.
