US bond yield are on the rise again, and that’s spelling trouble for the stock market. The yield on the 10-year U.S. Treasury note has surged to 4.57%, climbing from a low of 4% in early April. This uptick follows two major developments: a credit rating downgrade from Moody’s and concerns over inflationary pressures tied to potential tariffs. Moody’s decision to lower the U.S. government’s credit rating from AAA to Aa1 reflects growing unease about America’s fiscal health, particularly the projected $1.9 trillion federal deficit and rising interest costs.
Before the downgrade, yields had already been under upward pressure due to inflation fears. Now, with added strain from tariffs and debt concerns, bond markets are signaling that high yields may be here to stay. The 4.5% threshold is a key psychological level for investors. Historically, yields above this mark have drawn in buyers, pushing bond prices up and yields back down. But if investors now demand even higher returns due to inflation and fiscal instability, that trend could break, potentially sending yields toward the 5% mark and rattling equity markets.
Equity Valuations at Risk from Surging Yields
Until recently, equity markets had shrugged off rising US bond yield, confident that the 10-year Treasury would remain under 4.5%. That optimism helped power the S&P 500 to just over 5900, 19% above its early April low and near its record high of 6144. However, with yields now exceeding 4.5%, that assumption is being challenged, and stock valuations could take a hit.
Morgan Stanley’s Chief U.S. Equity Strategist Mike Wilson noted that surpassing the 4.5% yield level historically triggers what’s known as “valuation compression” a decline in the price investors are willing to pay per dollar of earnings. Currently, the S&P 500 is trading at about 21.8 times expected earnings, near the top of its range over the past three years. But as yields rise, relatively safer government bonds start looking more attractive compared to riskier equities, pushing the price/earnings (P/E) ratio lower.
According to Morgan Stanley’s data, if the P/E multiple falls to 19.5, the S&P 500 could decline by roughly 11%, bringing it down to just under 5300. This potential drop underlines the growing influence of US bond yield on market sentiment.
Investors Eye Risk-Return Balance as Earnings Yield Tightens
The broader challenge lies in the narrowing gap between expected stock returns and US bond yield. With a P/E ratio of 21.8, the S&P 500’s earnings yield, essentially the inverse of the P/E, is around 4.6%. That’s only marginally higher than the yield on government bonds, leaving investors with little incentive to take on equity risk.
Historically, investors have demanded a much wider gap, often around three percentage points, between bond yields and stock earnings yields. The current difference, under one percentage point, is near record lows and suggests that stocks may be overvalued relative to bonds. Unless Treasury yields decline soon, investors may start selling off stocks in search of safer returns, which could send equity prices downward.
As markets watch the 10-year Treasury closely, it’s clear that US bond yield have become a critical barometer for the health of the stock market. If yields remain elevated, Wall Street could be in for a rough ride.
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