The 10-year US Treasury yield is approaching the critical psychological level of 5% again, currently hovering around 4.96%, just a step away from the level first hit in October 2023. For investors, what really matters is not merely "whether it breaks 5%", but what forces drive the yield to cross this threshold.

If the rise in yields is mainly driven by resilient economic growth, its implications for the stock market and the overall economy will be vastly different from a rise triggered by rebounding inflation, growing fiscal concerns, or pressure within the US Treasury market itself. The 10-year US Treasury yield serves as a key benchmark for borrowing costs in the United States. It affects mortgage rates and corporate bond financing costs, and acts as a vital reference for valuing financial assets such as stocks.

Supply and demand imbalance pushes yields higher

Jason Ware, Chief Investment Officer at Albion Financial Group, stated that part of the recent yield increase stems from a supply-demand imbalance: massive issuances of US Treasury bonds and corporate bonds are competing for investor capital. He added that even if the 10-year yield breaks above 5%, he does not believe the market will "malfunction".

Ware believes that as long as the rise in yields is accompanied by healthy economic growth, it may not necessarily be bearish. He pointed out that the US economy remains resilient and core inflation stays stable. By contrast, if consumer spending or AI investment slows down, the stock market may become more vulnerable, rather than simply because the 10-year yield crosses a certain "arbitrary threshold".

Limited short-term pressure on the stock market

Niall O’Sullivan, Chief Investment Officer at Marsh Investments, said many companies currently driving US stock gains are not particularly sensitive to rising interest rates, so the immediate threat of higher yields to the stock market is limited. He thinks large-scale capital expenditure is still underpinning strong economic growth.

Nevertheless, the 5% threshold may gradually turn problematic as investors demand higher compensation for inflation and fiscal risks. High US federal deficits, heavy bond issuance and stubborn inflation have collectively pushed up the term premium. Meanwhile, oil prices have risen back above $100 per barrel, creating a new source of price pressure.

Rising fiscal and inflation risks

US Treasury Secretary Scott Bessent has attempted to ease pressure on long-end yields through measures such as expanding the buyback program. However, market participants argue such measures have limited effect on the fundamental forces driving yields upward.

Strategists at BMO Capital Markets noted that a more aggressive buyback program may help contain selling pressure but "cannot resolve the dominant fundamental factors pushing up 10-year and 30-year yields". In other words, if fiscal deficits, supply pressures and sticky inflation peRSIst, the upward trend in yields may continue.

An unruly spike is more dangerous

Another path toward 5% could be more worrying than fundamentals-driven gains: if stress emerges within the US Treasury market itself, yields may surge rapidly in a disorderly manner. George Awad, head of Gibraltar Capital, has been closely monitoring large leveraged hedge fund exposures supporting the Treasury market, including cash-futures bASIs trades.

He pointed out that if financing costs, margin requirements or market volatility rise abruptly, leveraged investors may be forced to close positions simultaneously, amplifying sell-offs and exacerbating market swings. Once such a scenario occurs, the impact will not be confined to Treasury bond prices; it will spill over to stocks, credit bonds and other assets via financing conditions and risk appetite.

The market can still bear the pressure for now

For the time being, investors seem willing to tolerate higher yields. BMO mentioned that when the 10-year US Treasury yield climbed to 4.85%, stock market pullbacks remained relatively mild, and the S&P 500 index still boasted gains of over 11% for the year.

But whether the market can continue to withstand this level remains to be seen. If yields keep approaching and stabilize above 5%, subsequent movements will hinge on whether they are driven by growth resilience, rebounding inflation, fiscal pressure or internal imbalances in the Treasury market. This will also determine how they affect the US dollar, US stocks and global risk assets.