Here's the silver lining for stocks and 5% Treasury yields

By Joy Wiltermuth

Higher rates mean higher costs for borrowers, but 5% isn't a level that's prone to sticking around in the Treasury market

The good thing about 5% Treasury yields in the past quarter-century is that they usually didn't stick around.

U.S. stocks took a breather from their rally to fresh record highs on Tuesday as investors confronted a gloomier inflation backdrop.

"The market is thinking there's a lot more downside coming down the pike than upside on inflation," Skyler Weinand, chief investment officer of Regan Capital, said in a phone interview.

With April's consumer-price index hitting a yearly rate of 3.8% - a three-year high - Weinand expects it will reach 4% in the next month or two. That's partly because of higher oil prices, but also because of lower inflation readings from a year ago that will be swept out for fresh data.

Tuesday's selloff also rippled through the $30 trillion Treasury market. That pushed the 2-year yield BX:TMUBMUSD02Y to 4%, the 10-year rate BX:TMUBMUSD10Ycloser to 4.5%, and the 30-year yield BX:TMUBMUSD30Y above 5%. That was the 30-year yield's highest level in about a year, and marks a psychologically important level for equity markets.

The 30-year yield tends to be the most sensitive to inflation, said Dominic Pappalardo, chief multiasset strategist at Morningstar Wealth, in emailed comments. "Sovereign bond yields have risen globally in recent weeks, as inflation concerns are not specific to the U.S.," he added.

For U.S. stocks, much of the past quarter-century has seen mild inflation and fairly low rates - until about four years ago. Stocks and bonds logged historic losses in 2022 after the Fed started quickly raising rates in a race to quell inflation.

When inflation is a problem, bond investors tend to demand more yield. That can push up borrowing costs, increase borrower defaults and pinch corporate profits.

Still, spikes to a 5% Treasury yield have been fairly short-lived over roughly the past 25 years. Historical data shows the 30-year Treasury yield was only at 5% or higher for at least 100 trading days two times since 2001, according to Dow Jones Market Data.

Of the two, the S&P 500 was lower by 7.6% six months after the 2002 episode, but up 10.1% six months after the 2004 occurrence, as the below chart shows. Given the limited set of data, it's unclear how stocks might react to higher rates if they stick around this time.

There are only two episodes from the early 2000s when 30-year Treasury yields were at 5% or higher for more than 100 days.

Climbing inflation this year has put the Federal Reserve in a tough spot in terms of delivering more rate cuts. It also seems to be opening the door a bit wider to potential hikes.

The odds of a hike by early December were at 30% on Tuesday, whereas a cut was at less than 3%, according to the CME FedWatch Tool. No rate change still had the highest odds, at almost 62%.

"Without a doubt, we're likely to see a few months of hot data on inflation, and perhaps several more months of energy-related commodity pass-through, depending on how the war in the Middle East and subsequent trade disruptions get resolved in the end," said Rick Rieder, BlackRock's chief investment officer of global fixed income, in emailed comments.

Tuesday's hot inflation reading and jitters around the Iran war could make Wednesday's release of April's producer-price index all that more important to Wall Street.

The S&P 500 SPX and Nasdaq composite COMP ended lower Tuesday after touching back-to-back record closes, while the Dow Jones Industrial Average DJIA eked out a 0.1% gain, according to FactSet.

Weinand at Regan Capital said that even with the higher inflation, he expects the S&P 500 to gain another 5% to 6% this year to about 7,700, given the exceptionally strong earnings in the first quarter and the power of the AI spending race.

-Joy Wiltermuth

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05-13-26 0722ET