What Happened to Shares When the US 10-Year Treasury Yield Hit 5% in the Past?

Global bond markets are imploding. The yield on the US 10-year Treasury recently hit 5%, its highest level since 2007. A day later the Federal Reserve raised rates for the first time in three years, to a range of 3.75% to 4%, and signalled more may follow. Closer to home, Australia’s 10-year government bond yield has pushed above 5.3%, near its highest since 2011. 

That raises a couple of important questions for investors. What does a 5% ‘risk-free’ return in the world’s most important bond market mean for global equities? And after years of disappointing returns, is this finally the time to buy bonds?  

History offers useful, albeit not simple, answers. 

Key Takeaways 

• The US 10-year has crossed 5% only a handful of times this century, with very different outcomes for equities each time. 
• In 2007, yields peaked months before shares did, and the crash that followed came from the credit system rather than the bond market. 
• In 2023, the 5% level marked the top in yields, and investors who bought shares or bonds near that point were rewarded within months. 
• Starting yields have historically been the best guide to bond returns over the following decade, making today’s entry point the most attractive in about 15 years. 
• The main risk is persistent inflation, which could push yields higher still and lead to shares and bonds falling together, as occurred in 2022. 
  

Why 5% Is Significant but Not Magic  

The thing with the US 10-year Treasury yield is that it’s the global benchmark against which almost every asset is priced.  

When it rises, future earnings are discounted more heavily and the bar for riskier investments goes up.  

‘Some investors see 5% as a threshold above which financial markets might go into meltdown. While we aren’t convinced that 5% is that magic number, higher Treasury yields would certainly pose a risk to the sustainability of the US’s public finances as well as threaten equities.’ – Capital Economics’ John Higgins 

The yield started 2026 at 4.15% and dipped below 4% in February before reversing once the war with Iran began. Since then, it has been trending higher. 

The reason is markets are seeking greater compensation for rising risk.  

With oil just under US$100, US Government spending ballooning, US inflation at 3.4% and the Fed’s preferred PCE measure at 3.7%, bond investors are demanding higher compensation to lend to the US Government for a decade.  

This issue is far from over. Yields appear to remain in a concerning uptrend.  

Case in point: updated projections show 16 of 18 Fed officials expect at least one more rate increase this year. 

Before you join the chorus of panic, some perspective may help here.  

For most of the four decades before the GFC, a US 10-year Treasury yield of 5% or higher was normal rather than alarming, as the Federal Reserve’s own data shows.  

What’s unusual of late has been the speed of the yield rise during this latest 5%+ US 10-year Treasury yield era.

A Journey Through History: What Happened to Equities Every Other Time 

Let’s take a trip down memory lane for some historical context here: 

1999 and 2000: When Valuations Did the Most Damage 

Remember the cautionary tale that was the dot-com bubble? 

It was the end of 1999 and the 10-year Treasury yield was well above 5% – 6.4%, in fact. 

More to the point, the gap between the S&P 500’s earnings yield and the 10-year Treasury yield, a rough gauge of the equity risk premium, hit its low at the end of 1999, three months before the dot-com bear market began.  

There was a massive market sell-off just around the corner. The index went on to fall 49% from peak to trough.  

Before you read too much into the equity risk premium as a market guide, it’s worth bearing in mind it was negative through much of the bull market during the 1980s and 1990s. So, by itself, it’s a poor timing tool. 

Having said that, it’s also worth understanding the current similarity with that episode. The US equity risk premium is currently at its lowest level in over two decades. 

2007: A Symptom, Rather Than the Cause 

The GFC is the next stop in our history tour. 

Yields rose above 5% in spring 2007 and peaked in June, yet the S&P 500 kept climbing for another four months to a record on 9 October 2007, then fell a brutal 57% by March 2009.  

In this case, it has to be added that the greatest damage was done by subprime mortgages and the banking system, rather than rising bond yields per se. 

Rising yields did, however, expose weaknesses in the financial system that time and may well again. The lesson from this episode is how badly US and global equities were hit. 

2023: Marked the Top in Yields 

The 2023 episode was markedly different.  

The US 10-year Treasury yield spiked to 5.02% for a short while on 23 October 2023, buyers flooded in, and the yield fell as low as 3.79% by late December.  

A dovish shift from the Fed helped send the S&P 500 to a 24% gain for the year, and a fresh record in January 2024.  

Buyers of 10-year Treasuries at a yield near 5% collected both solid income and capital gains that time around. 

Finding Commonality in the Pattern of Events 

There are a couple of common lessons worth noting from those historical events: 

1. The absolute level of 10-year Treasury yields is less significant than why yields are rising and the current backdrop of equity market valuations.  
2. Yields driven higher by thriving economic growth are easier to absorb than those driven by inflation or deficits (like now). 

Are Bond Markets Offering a Buying Opportunity? 

For bond investors, the most dependable relationship is between starting yields and subsequent returns over the next decade. 

Research shows that this relationship is far stronger for 10-year bonds than for short-term bills.  

Australian 10-year yields recently reached 5.4%, their highest level since May 2011.  

By way of comparison, Vanguard’s latest 30-year Index Chart shows Australian bonds returned 5.2% a year and cash 4% over that longer-term timeframe. 

Higher starting yields improve the risk equation for bond investors.  

Consider a bond fund yielding 5% with an average duration of six years. If yields rose 1% over the next year, the expected 6% price fall would be largely offset by income, leaving a 1% loss.  

In contrast, if yields fell by 1%, the total return would be 11%.  

In other words, yields would need to rise more than 0.8% in a year to wipe out a full year’s income. Whilst the risk of losing a year’s income isn’t exactly comforting, it’s a cushion that bond investors haven’t had for many years. 

Or Does the Risk in Bonds Remain on the Downside? 

The case against owning bonds now is that inflation refuses to fall and may trend higher. That would be bad news for bond markets, because rising yields mean falling bond prices. 

History shows how far this can run. In 1973 and 1974, Australian 10-year yields climbed from 5.7% to 9.5%, and yields that already looked high kept rising. In 2022, the main US bond index lost 13%, its worst year on record, while shares fell at the same time, so bonds offered no cushion. 

Supply is another pressure. Large government deficits across developed markets, particularly in the US, are adding to bond supply, which may serve to push yields higher still. 

Interpreting the 5% Level as a Nuanced Signal  

History doesn’t support treating a 5%+ US 10-year Treasury yield as an automatic sell signal. In 2007 the real danger lay elsewhere, and in 2023 the 5% mark was the top in yields and a springboard for shares and bonds.  

The combination that investors tend to be most cautious about is stretched equity market valuations plus persistent inflation. Both those conditions are present today. 

No one knows what’s coming next, but it may be wise to be ready for some volatility. That means holding a solid cash weighting and having some exposure to shorter-duration and inflation-linked bonds, both of which are well placed to navigate the growing risks plaguing bond markets. 

And remember: market sell-offs are a normal part of the investment journey, rather than a reason to sell. 

Frequently Asked Questions 

Why Does the US 10-Year Yield Matter to Australian Investors? 

It sets the global benchmark for risk-free returns and influences Australian bond yields, the Australian dollar and share valuations. Australian 10-year yields have closely tracked the recent rise in US yields. 

Do Rising Bond Yields Always Hurt Share Prices? 

No. Shares often rise alongside yields when economic growth is strong. Problems tend to arise when yields climb because of inflation, or when share valuations are already stretched. 

Is It a Good Time to Buy Bonds When Yields Are High? 

Higher starting yields have historically meant better bond returns over the following decade, though short-term losses remain possible if yields keep rising. 

Yields near 5% offer genuine income, a buffer against further rises and renewed ability to cushion portfolios if growth slows.  

What Is Bond Duration? 

Duration measures a bond’s sensitivity to interest rates. A duration of six years means the price would fall about 6% if yields rose one percentage point, and rise by a similar amount if they fell. 

Are Bond ETFs Better Than Term Deposits? 

They do different jobs. Term deposits lock in a rate with capital certainty, while bond ETFs and funds are priced daily, can rise or fall in value and may benefit if rates decline. 

Disclaimer: This article is prepared by Simon Turner. It is for educational purposes only. While all reasonable care has been taken by the author in the preparation of this information, the author and InvestmentMarkets (Aust) Pty. Ltd. as publisher take no responsibility for any actions taken based on information contained herein or for any errors or omissions within it. Interested parties should seek independent professional advice prior to acting on any information presented. Please note past performance is not a reliable indicator of future performance.