Bond Yields Surge’s Potential Impacts on the Equity Market

Review the latest Weekly Headings by CIO Larry Adam.

Key Takeaways

  • The sharp rise in Treasury yields has caught the market’s attention
  • Earnings growth should be the catalyst to drive the S&P 500 higher
  • Investor overoptimism remains the biggest risk overhanging the market

Hello 2025! US equities had a stellar 2024, with the S&P 500 up 25%, but the year ended on a softer note. The sharp rise in bond yields has caught the market's eye, with the 10-year Treasury yield climbing over 100 basis points since the Fed started cutting interest rates last September, with nearly half of that increase happening since early December. Despite this, the S&P 500 has largely weathered the storm, gaining over 5% since the Fed began its easing cycle, driven by robust economic growth and rising earnings. Yet, as we enter 2025 with equity gains stalling and yields pushing higher, two key questions arise: Can equities sustain their momentum in the face of higher interest rates? And at what point do higher yields pose a challenge for the equity market? Here are our thoughts on the recent bond yield surge and its potential impact on the equity market:

Treasury Yields Remain Front And Center | Treasury yields continue to march higher, with the 10-year yield now up a stunning 100+ basis points since the Fed’s first rate cut—surpassing last April’s peak (4.7%). Key drivers of the rate increase include:

  • Resilient Economic Growth—The economy has not skipped a beat since the Fed preemptively cut rates to preserve growth. In fact, the US economy is on track to end 2024 with solid momentum (Atlanta Fed 4Q24 GDP Now: +2.7%) and growth expectations are marching higher for 2025—helped by Trump’s pro-growth (i.e., tax cuts, deregulation, America First) initiatives. At the same time, inflation has proven stickier than expected. Case in point: The Prices sub-index of the ISM Services survey recently ticked up to nearly a 2-year high. These dynamics have led to a major reset in Fed rate cut expectations, with only one cut (rather than the four previously) expected in 2025.

Our View: The US economy is resilient although we expect GDP to slow slightly to 2.4% this year from 2.7% last year. The slowing will be evident in job creation as the pace of monthly job growth will slow from ~190k to ~140k. Inflation should continue to decelerate and approach 2%, especially early in the year due to favorable base effects and lower energy and shelter prices. Tariff risks appear overblown.

  • Fiscal Worries Ramp Higher—Market anxiety around Trump’s spending plans amid an already unsustainable fiscal trajectory has put upward pressure on bond yields. This week’s $119bn worth of new Treasury supply was a lot for the market to absorb—driving yields modestly higher to entice buyers. These worries will linger as there remains uncertainty about how much the new administration’s policy initiatives will add to the deficit (currently at ~6% of GDP) and growing level of debt (which recently surpassed $36t).