Rising Yields Pose Unappreciated, Serious Risks for U.S. Equities

By the Curmudgeon with Victor Sperandeo

Introduction:

U.S. Treasury notes and bonds have been in a major bear market since July 2020 -- the longest (almost six years) bond bear market in financial history!

During that same period, equities have staged one of the most extended and liquidity-driven bull runs in modern history. Such a divergence is not sustainable.

Between July 1, 2020, and May 22, 2026, the Nasdaq 100 Total Return index posted a cumulative return of approximately 175% to 185%, while the S&P 500 Total Return index returned approximately 120% to 125% over the same period, assuming the reinvestment of dividends.

These figures reflect the explosive growth of mega-cap tech and AI-linked companies, which are heavily weighted in both indexes.

->Will higher note and bond yields sink this seemingly never ending equity bull market?

Drivers Behind Higher Long-Term Yields:

The latest leg higher in Treasury yields is being blamed mostly on rising oil prices. The Strait of Hormuz disruption pushed Brent and WTI crude oil from the mid-$60s to above $110, embedding another inflation impulse into an already fragile system.

The 30-year U.S. Treasury bond yield hit 5.20% on May 19th, the highest level since mid-2007, just before the 2008-09 financial crisis. The 10-year yield topped 4.68% the same day before retreating but remains above 4.50%. The trend is global: Yields on United Kingdom gilts, German Bunds, and Japanese government bonds have also been climbing, in tandem with the rise in crude-oil prices since the Iran war began in late February. That’s depicted in these two charts:

Victor’s Comments:

1. All-time lows for long bonds concurrently with all-time highs for stocks:

The EDV ETF (Vanguards Extended Long-Term Bond ETF) declined to an “all time” low on May 19th, while the S&P 500 and NDX 100 traded at all-time highs on May 14th -- just five days earlier!

Meanwhile, the Michigan Consumer Sentiment survey fell to 48.2 on May 8^th - a historic all-time low. Evidently, the “K Shaped” economy is morphing into an “I“ economy.

2. Mortgage rates, the Fed, Government Spending and Budget Deficits:

The 10-year U.S. Treasury note serves as the primary benchmark for mortgage rates, which are currently 6.69% for a 30-year fixed mortgage. That is double the rate from 3.5 years ago and makes buying a home unaffordable for many people.

In my view, people not being able to afford a house is COLLATERAL DAMAGE to the Fed’s policy actions. Moderate long-term interest rates are generally treated as a subordinate or tertiary goal for the Fed, as it’s not part of its “dual mandate” of price stability and moderate unemployment.

The actual wording of the Federal Reserve Act of 1913 states the Fed should “maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and MODERATE LONG-TERM INTEREST RATES” (emphasis added).

However, long-term rates are generally not controllable by Fed policy without extreme actions, like yield curve controls or Quantitative Easing (QE).

Long term interest rates are directly influenced by federal government spending and its adverse effect on budget deficits. So, the Fed gets some cover here from Congress’ approval of budget busting spending bills and “tax cuts” which have greatly increased deficits (much more below).

Structural Problems for U.S Debt:

Focusing on oil alone misses the bigger picture. The bond market is repricing a structural problem, not a transient one.

Robin Brooks, senior fellow at the Brookings Institution and former chief economist at the Institute for International Finance, usefully frames the three drivers: persistent fiscal excess, no post-pandemic retrenchment, and inflation that refuses to decline.

The numbers are not ambiguous. U.S. debt held by the public is now 102% of GDP. The deficit is over 6% of GDP and is projected to stay there for a decade—roughly 60% higher than the long-term norm. Meanwhile, interest expense alone has quietly become a trillion-dollar annual line item, already exceeding defense spending.

And there will be more borrowing. A 44% jump in U.S. military spending to $1.5 trillion is on the table. Europe and Canada are moving in the same direction, targeting defense outlays of 5% of GDP. This is not cyclical stimulus. It is a structural ratchet higher in global government spending.

Unlike in the recent past, Treasury notes and bonds are no longer a hedge against falling stock prices. That motivates investors to demand a higher “inflation premium” in U.S. Treasury yields.

A Debt-Inflation Doom Loop? (Source: Greg Ip, Wall Street Journal)

Deficits and inflation, treated so far as separate and distinct, may feed off each other. Anxiety about the cost of living has eroded politicians’ popularity everywhere, making them even less willing to propose cuts to government benefits or higher taxes.

If the Fed must repeatedly raise rates, that adds to deficits. The Committee for a Responsible Federal Budget estimates the recent rise in rates, if sustained for a year, would add $200 billion to deficits over a decade. Leaders might pressure central banks against raising rates, which would also lead to higher inflation.

Curmudgeon Note: Fed Funds and 10-year U.S. rates have moved in OPPOSITE directions sine the Fed started to cut the Funds rate (by 50bps) on September 18, 2024. The U.S. Treasury Note yield was 3.64% one day before, but on May 22^nd, after 175 bps of Fed rate cuts, it was 4.56% --an increase of 0.92%!

Global Flows Decrease, Higher Yields, Shorter Duration Funding:

For years, foreign capital flowed into U.S. Treasury notes and bonds because yields elsewhere were artificially suppressed. That regime is ending. Japan’s 10-year yield above 2.5%—versus sub-1% norms for decades—is not a footnote. It is a regime shift. When Japanese and European investors can earn acceptable returns at home, the U.S. must clear its debt at higher yields due to the absence of foreign buyers.

The U.S. Treasury Department’s response—funding increasingly at the short end of the yield curve—has bought time but increased fragility. Rolling short-term bills works when central banks are easing. It becomes dangerous when policy reverses. With Fed rate cuts repriced into hikes, that strategy begins to look less like optimization and more like duration avoidance at exactly the wrong moment.

Now layer in inflation. Headline and CPI, PPI and PCE inflation numbers have not come down and high oil prices reinforces higher inflation to come (unless there is “demand destruction,” leading to recession and disinflation, which is Victor’s thesis).

As a result, Central banks are not easing—they are tightening (e.g. Reserve Bank of Australia +25bps on May 5^th) or threatening to do so. Markets that were positioned for synchronized global rate cuts are now facing rate hikes later this year.

Supply vs Demand for U.S. Bonds:

The real problem is supply. Persistent 6% deficits, $1 trillion in annual interest expense, and a structural increase in defense spending mean one thing: more issuance, for years. At the same time, global buyers are no longer captive. Japan and Europe now offer yield. Capital is staying home.

The bond market is demanding discipline. That’s where the “bond vigilantes” come in. Yet there’s no evidence it’s going to get it.

Huge Risk for Equities from Rising Bond Yields:

This is where equity investors should pay attention. Rising yields are not just a valuation issue. They are a potential shock for companies that have to borrow to fund ongoing operations and capital expenditures.

Most important is the balance sheet effect. U.S. corporations have spent the better part of a decade issuing bonds at artificially low rates. Roughly a third of investment-grade debt and a larger share of high-yield debt will need to be refinanced over the next three years. Each turn higher in corporate yields feeds directly into interest expense.

We are already seeing it already. Interest coverage ratios are deteriorating, especially in lower-rated credits. The share of corporate cash flow devoted to servicing debt is rising, not falling. That is before any cyclical slowdown.

Next, the mechanical effect: higher U.S. Treasury interest rates compress equity multiples. The S&P 500’s forward P/E has historically shown a strong inverse relationship with the 10-year yield. A move toward 5–6% on the long bond is not a rounding error—it implies a materially lower equilibrium multiple, even before earnings adjust upwards.

Third, the buyback channel is at risk. Equity markets have been supported by persistent corporate repurchases, financed in part by cheap debt. As borrowing costs rise, that arbitrage disappears. Buybacks slow, removing a key marginal bid for equities.

Fourth, private markets are beginning to crack. Leveraged buyouts underwritten at 5–6x EBITDA with floating-rate debt now face financing costs that have doubled. That pressure feeds back into public markets through reduced deal activity, lower valuations, and forced asset sales.

Finally, history is not kind when rates overshoot growth. When nominal yields exceed nominal GDP growth—as already seen in the U.K. and now Japan—the system enters a debt-deflation feedback loop. Debt becomes harder to service, forcing either austerity, monetization, or default risk repricing. None of those are equity-friendly outcomes.

The consensus still treats higher yields as a sign of economic strength. That is backward. At this stage, higher yields are a sign of fiscal saturation and capital scarcity.

Victor’s Market Views:

l At his first FOMC meeting on June 17^th, I believe new Fed Chair Kevin Warsh will announce a lowering of the Fed’s balance sheet (QT) coupled with a cut in Fed Funds of 25 to 50 bps. There is no confirmation inflation is as high as the BLS and Fed claim.

l Gold, silver and other precious metals are trading +4% above their yearly lows. I’m a long-term Bull on Gold, but am bearish short term as the yellow metal may drop to drop to $3800 after the June Fed meeting.

l Bitcoin, thought of as an inflation hedge, is down ~-9% for the year and close to its recent lows.

l Bullish on 5-year U.S. T-Notes and remain long futures contracts.

l Bearish on stocks, but flat at this time. I’m looking to buy puts in mid-June.

l Bullish on oil but flat for my account.

Conclusions:

Higher yields are tightening financial conditions directly:

· Corporate refinancing is resetting higher; interest coverage is deteriorating.

· Buybacks—funded in part by cheap debt—are at risk of slowing.

· Private equity and leveraged credit are already under pressure from floating-rate exposure.

· The Treasury’s shift to short-term funding becomes a liability if the Fed is forced back into hikes.

There is also a critical threshold to watch: when long-term yields approach or exceed nominal GDP growth, debt dynamics become unstable. The U.K. has crossed that threshold. Japan is crossing it now. The U.S. is moving in that direction. Equities have not priced in this regime.

With 62% of global fund managers in Bank of America’s May 2026 survey anticipating the 30-year Treasury yield to exceed 6%, the market risk is less a linear repricing than a potential regime shift. Already sky-high equity valuations, anchored to a low interest rate regime, are unlikely to adjust smoothly to an environment where borrowing costs are materially positive in real terms.

If yields continue higher, equities will not easily “digest” it. Instead, they will reprice to it. If that repricing triggers a reallocation back into bonds, it will not be a sign of stability—just the next phase of the same problem.

After six years of a bond bear market and a simultaneous equity boom, the adjustment is unlikely to be gentle. Either yields reverse sharply—which requires a growth scare or crisis—or equities adjust downward to reflect a world where money is no longer free. The bond market is forcing the issue. Equities are late to it, but may soon adjust.

End Quote:

Never forget the words of Jean Claude Junker, the former President of the European Commission:

“When it becomes serious, you have to lie.”

….……………………………………………………………………………………………………………..

Stay calm and healthy. Wishing you success and good luck. Till next time….

The Curmudgeon
ajwdct@gmail.com

Follow the Curmudgeon on Twitter @ajwdct247

Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever-changing and arcane world of markets, economies, and government policies. Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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