How Will Rising Treasury Yields Affect the Stock Market?

In Q4, long duration U.S. Treasury bond yields moved sharply higher. Mitch looks at 3 potential reasons yields may rise further, and what each means for the stock market.

Are Rising Treasury Yields Negatively Impacting the Stock Market? Long-duration U.S. Treasury bond yields pushed higher in Q4 2024, dashing investor expectations that the 10-year would remain below 4% as inflation continued to moderate. The equity market’s response to the steep move in bond yields was swift—small-cap stocks sold off sharply, and the equal-weighted version of the S&P 500 fell back below pre-election levels.1 10-Year U.S. Treasury Bond Yields Moved Sharply Higher in Q4 2024 Source: Federal Reserve Bank of St. Louis 2 Your Q1 Edge: Unlock Key Market Insights Don’t let market uncertainty hold you back. Take control of your portfolio with the January 2025 Stock Market Outlook Report 3—your guide to making smarter, more confident investment decisions this quarter. Inside, you’ll uncover: Zacks Rank S&P 500 sector picks Current asset allocation guidelines Zacks forecasts for the months ahead Zacks Rank industry tables Buy-side and sell-side consensus at a glance And much more! If you have $500,000 or more to invest and want to take charge of your financial journey, click on the link below to get your free report today! IT’S FREE. Download the Just-Released January 2025 Stock Market Outlook 3 For investors, the question is not whether equity markets can tolerate higher long-duration bond yields. We know they can. The question is, why did bond yields rise so quickly and significantly, and was stocks’ negative response because of the pace of change or the new level of rates? In thinking about the current macroeconomic environment and expectations for what lies ahead, I assign three potential reasons why Treasury yields would move higher: Expectations for economic growth are going up, tied to expectations for pro-growth, pro-cyclical policies from the incoming administration. Inflation expectations are going up, due to strong expected growth in an economy near full capacity or because of other factors, like trade policy (tariffs). The bond market becomes increasingly concerned about fiscal health/sustainability, with growing deficits necessitating higher levels of bond issuance. Let’s take each of these reasons/factors in turn. First, if the upward move in long-duration Treasury bond yields can be attributed to a growing economy and expectations for a cyclical upturn in the year(s) ahead, then I do not think investors would have much to worry about. Historically, accelerations in economic expansions have helped stocks, because profits tend to increase as the economy expands. Markets and the economy could likely absorb higher rates in this case. The second point regarding inflation is a bit more complicated. We have seen how sudden inflation events (2022) can send rates soaring and stocks plummeting. Smaller moves in the inflation rate, however, tied to changes in realized growth have not historically been automatically bearish. In fact, looking back at S&P 500 returns by decade and adjusting for inflation, we find that the highest real returns occur when inflation is 2% to 4%. The critical piece here is the source of inflation—if the economy is at full capacity, growing very strongly, and price pressures follow, I would characterize that as a ‘good problem’ to have. Tariffs represent the other side of this inflation coin. We know from the first Trump administration that tariffs were often used as a negotiating tactic to work out new trade terms. In a scenario where new tariff threats are diluted to something like 20% on all imports from China with additional tariffs on autos from the EU and Mexico, I could see a modest 30 to 40 basis-point increase to PCE inflation in 2025. This bump would be easily identifiable in the component details, and I do not think it would prompt a Fed response or a surge in long-duration Treasury yields. 10% universal tariffs would be a different ballgame, in my view, and would be a major inflation and market risk. Yields moving higher in this scenario would be bad for stocks. The final reason yields could go up is the U.S. fiscal situation. The starting point for the U.S. in 2025 is not great—the debt-to-GDP ratio is approaching a new all-time high, and the deficit relative to GDP is about 5% wider than it has historically been when the economy was at full employment. In my view, this fiscal issue is somewhat of a wild card. On the revenue side, we expect a full extension of the 2017 tax cuts, including reinstatement of some expired business investment incentives and modest additional personal tax cuts worth about 0.2% of GDP (taxes on tips, overtime pay). On the spending side, there is an effort underway with the Department of Government Efficiency (DOGE) to reduce government spending, but the scope for spending cuts to materially reduce the deficit gap appears limited. There’s a scenario where spending actually goes up, not down, in 2025, which could factor as a negative surprise in Treasury markets and cause some consternation in equity markets. Bottom Line for Investors My base case is that 10-year U.S. Treasury bond yields will remain above 4% in 2025, especially if U.S. economic growth remains strong—as I currently expect it will. Some investors worry that higher bond yields will hurt the stock market’s chances of performing well, but I would point out that historically, value and growth stocks have done quite well even with the 10-year Treasury bond in the 4% to 5% range. If long-duration Treasury bond yields remain elevated as the economy grows and the new administration seeks to bring deficit spending down, that’s a scenario I think would help—not hurt—stock market performance. As markets adjust to shifting conditions, staying ahead is essential. Our Just-Released January 2025 Stock Market Outlook Report 4 can help you position your portfolio for what's next. This report looks at several factors that are producing optimism right now and contains some of our key forecasts to consider such as: Zacks Rank S&P 500 sector picks Current asset allocation guidelines Zacks forecasts for the months ahead Zacks Rank industry tables Buy-side and sell-side consensus at a glance And much more! 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