Bond Market Warning Signs: Why Investors Are Getting Nervous

TLDR

10-year Treasury yield has risen to 4.57%, up from 4% in April following Moody’s US credit rating downgrade Stock market valuation concerns increase as yields cross the critical 4.5% threshold Trump’s proposed tax bill could increase US debt by $3.8 trillion over the next decade Global investors showing caution with European markets down and Bitcoin reaching all-time high Oil prices fell over 1% on reports OPEC+ is discussing production increases

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The US bond market is showing signs of stress as yields continue to climb, reaching levels that could spell trouble for stock markets. The 10-year Treasury yield has risen to 4.57%, up from a low of 4% in early April, crossing a threshold that has historically pressured equity valuations.

10-Year Yield Futures,May-2025 (10Y=F)

The catalyst for this recent jump came last week when Moody’s downgraded the US government’s credit rating from AAA to Aa1. This decision was based on the growing federal deficit, projected to be $1.9 trillion this fiscal year, and increasing interest payments on the national debt.

Even before the downgrade, yields were struggling to move below 4% due to concerns that proposed Trump tariffs could push inflation higher. Now markets face a double challenge from both the credit downgrade and potential tariff impacts.

The current yield level sits at a critical juncture where buyers have historically entered the market to drive bond prices higher and yields lower. If these buyers don’t appear this time, it may signal a fundamental shift in market dynamics.

A sustained break above 4.5% puts the 5% yield level within reach, a marker touched several times in recent years that creates significant market anxiety.

Stock Market Implications

Until recently, higher yields hadn’t seriously impacted stocks. The S&P 500 remains 19% above its early April closing low for the year and not far from its record close of 6144. However, the crossing of the 4.5% yield threshold forces the stock market to confront new valuation realities.

S&P 500 INDEX (^SPX)

Morgan Stanley’s chief US equity strategist Mike Wilson notes that when 10-year yields break above 4.5%, modest valuation compression tends to follow. This compression reflects a lower price-to-earnings multiple for stocks.

The S&P 500 currently trades at 21.8 times expected earnings, which is relatively high for the past three years. Higher bond yields make Treasury returns more attractive, potentially drawing investors away from riskier equities.

Based on historical patterns, if the P/E multiple falls to 19.5 times (as it has when yields crossed 4.5% in early 2024), the S&P 500 could drop about 11% to around 5300.

Trump Tax Bill and Global Impact

Investor caution is growing ahead of a crucial vote on President Donald Trump’s tax bill. The non-partisan Committee for a Responsible Federal Budget estimates that the bill, which would extend Trump’s 2017 tax cuts and increase military spending, will add $3.8 trillion to US debt over the next decade.

UBS economist Paul Donovan noted that while final details are still emerging, “the broad impact is to push the US further along a rising debt path. Bond investors are less than happy.”

The effects are being felt globally. In Europe, stock markets in London, Paris, Milan, and Frankfurt all dropped more than 0.5%. Germany’s long-term bond yields hit two-month highs as global yield curves steepened.

Japan’s bond market has also come under scrutiny given it has the highest debt-to-GDP ratio of any major economy. The 30-year Japanese Government Bond yield hovered near record highs at 3.155%.

Market Reactions and Alternative Assets

Investors appear to be seeking alternatives to US assets. Safe-haven gold rose to a two-week peak, while Bitcoin jumped to an all-time high.

Oil prices fell more than 1% following reports that OPEC+ is discussing production increases for July. Brent futures fell to $63.86 a barrel, while US West Texas Intermediate crude dropped to $60.60.

The lackluster US 20-year bond sale on Wednesday reinforced what some are calling a “Sell America” narrative. Yields on 30-year Treasury bonds reached 5.108%, the highest since October 2023, while the 20-year yield hit 5.126%, its highest since November.

Trade concerns also remain on investors’ minds. Finance ministers at the Group of Seven meeting in Canada are working toward an agreement on a joint communique primarily covering non-tariff issues, while officials from Thailand and Japan stated that currency markets were not part of their trade discussions.

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