Stocks Continue to Shrug Off Rising Treasury Yields: The Critical 7% Threshold

US Treasury yields have continued their upward trajectory recently, yet equity markets have shown surprising resilience. Experts from Strategas Research Partners indicate that a much more severe bond market selloff would be required before stocks experience significant pain. This is attributed to investors' reluctance to exit the equity asset class and the market's current robust rotational nature.

While the 10-year Treasury yield has recently climbed to around 4.72%, market professionals believe this level is not yet a 'pain point' for stocks. BofA strategists emphasize that the critical threshold that would truly hurt equity markets is a 10-year Treasury yield of 7%. Historical data since 1986 shows that the S&P 500's median forward price-to-earnings ratio has remained stable as long as the 10-year yield stayed between 0% and 7%. However, once yields surpass the 7% mark, the median P/E ratio historically plummets to 12.1, and average monthly S&P 500 returns drop to -0.6%.

One of the reasons behind this resilience is the improving internal dynamics of the stock market. For instance, the percentage of S&P 500 stocks trading above their 200-day moving average has increased from 50% to 75% during the recent volatile eight-week period. This indicates an improvement in the overall health and strength of the market. Furthermore, a strong earnings season and the investment boom in artificial intelligence (AI) are also keeping investor appetite for equities alive.

The rise in long-term Treasury yields is primarily driven by the US federal budget deficit and the massive ongoing borrowing needs. The federal deficit reaching a record $432 billion in July alone, and the cumulative fiscal year 2026 deficit already surpassing the entire previous year's total at $1.799 trillion, are major concerns for the market. Declining foreign demand from major buyers like Japan and China, who are reducing their Treasury holdings, also adds upward pressure on yields. Additionally, AI investments accelerating capital flows into technology companies are diverting funds from traditional Treasury demand.

Analysts anticipate that equity markets can largely withstand the current interest rate environment. According to Capital Economics, yields would need to rise significantly further to pose a major headwind for the equity rally. Federal Reserve Chair Kevin Warsh's 'regime change' approach to central bank communication and his rhetoric about allowing markets to determine appropriate rates have also contributed to the perception among long-term bond investors that the Fed is not sufficiently committed to restoring price stability, thereby contributing to rising yields.

Looking ahead, if 10-year Treasury yields reach the 5.0% to 5.25% range, there could be a risk of a 10-20% correction in equity markets. Yields above 5.25% could increase government borrowing costs, leading to a fiscal doom loop and pushing yields even higher. For now, however, market participants believe that the strength of AI-driven earnings growth and overall market internals can offset the negative impacts of rising yields.