For years, 5% on the benchmark US 10-year Treasury yield was viewed as the point at which global financial markets would start hitting turbulence. That threshold is beginning to look less like a ceiling and more like a waypoint.
This month's breach of 5% - something that has happened only briefly in recent decades - has forced investors to contemplate an unsettling question: What if 6% is the new number that should be keeping them awake at night? Reuters reported.
The latest move above 5% has not lasted long enough yet to properly test that theory. But it has always been a psychological marker rather than an automatic tripwire, according to BlueBay Asset Management's head of market strategy, Mike Bell.
"People think of it as if there's a magic number for Treasury yields at which it becomes a problem, (but) it's a relative number, not an absolute number," Bell explained.
What matters is how Treasury yields compare with other key investment metrics, particularly the earnings yield on stocks. Bell says that relationship is now approaching an inflection point, potentially setting the stage for an equity selloff.
History offers some guidance. MSCI's main world stocks index halved in value the last time the 10-year Treasury yield broke 5%, which was just before the global financial crash. It suffered a similar slump less than a decade earlier when a near 6.8% spike helped pop the dotcom bubble.
JP Morgan's analysts say one of the reasons why the pain-point might now be above 5% again is a "key structural shift" in the global economy, with AI, healthcare and services playing a bigger role. Many of those firms are spending and expanding, regardless of the level of borrowing costs.
That means "the traditional interest-rate channel looks materially less binding" and the "breaking threshold" of stock markets may be "meaningfully higher, potentially in the 5.5%-6.0% range", JP Morgan said, referencing the views of some of the major investors at one of its most recent conferences.
PROFOUND REPRICING
In the $29-trillion Treasury market, which anchors pricing for virtually all financial assets, a shift from 5% to 6% would represent a profound adjustment in the global cost of capital.
A 6% Treasury yield would imply either significantly higher inflation expectations, growing concerns about US fiscal sustainability, a conviction that interest rates will remain elevated for years - or a mix of all three.
Federal Reserve policymaker Austan Goolsbee said this week that he didn't know whether markets would react differently to a lengthier period of 5% yields than they had in the past.
Paul Jackson, Invesco global head of asset allocation research, said investors focus on Treasury yields for a simple reason: Treasuries represent the world's risk-free benchmark and at above 5%, investors can lock in the highest returns on US bonds since 2007.
Jackson's own calculations show world stocks start to drop when the 10-year yield has traded at an average of 4.72% for 12 months and then rises.
That tipping point remains some way off for now - the 12-month average is currently around 4.34% - but Jackson said he was already dialling back on stocks and switching some money into government bonds to cash in on the juicy yields.
"If Treasury yields keep rising then there is a risk that the stock market is lower in 12 months' time," he said.
EMERGING QUESTIONS
Emerging markets, which have enjoyed something of a hot streak in recent years, are often among the first casualties when US yields surge.
Higher Treasury returns tend to strengthen the dollar and make dollar-denominated assets more attractive. That sucks capital away from EM economies and can tip hard-up countries into crisis if the cost of servicing their dollar-denominated debt spirals.
Data on investment flows shows last week saw the biggest exodus from EM bond funds in months, with billions also withdrawn from equity funds. Issuance of emerging-market sovereign debt has also been notably lighter than usual this month.
"It's not an optimal picture for EM," said Alison Shimada, Head of Total Emerging Markets Equity, Allspring Global Investments, although she stressed that for now nothing was going "horribly wrong" and therefore remained "constructive".
Perhaps the biggest risk is psychological.
Once investors start asking whether 6% is attainable, the debate shifts beyond a temporary spike in yields. It becomes a broader reckoning with the possibility that the era of abundant liquidity and ultra-cheap money has ended, forcing global asset prices to adapt to a permanently higher cost of capital.
Premier Miton CIO Neil Birrell said while stock markets were showing no sign of collapsing right now, that might be because investors weren't yet plugging in 5%-plus yields into their longer-term profit forecasting models.
"The markets look fine until everyone re-runs their valuation models," Birrell said. "Ultimately, the numbers are the numbers and they've got to come through."
