Why 5% Is The Treasury-yield Level That Freaks Investors Out

• The 10-year Treasury yield is is striking distance of 5%.
• That level is a key psychological threshold that investors see as a threat to stocks.
• "If we were to break above 5%, it would cause stresses," one source said.

A 5% 10-year Treasury yield is something that keeps investors up at night.

Yields were edging up again on Friday after briefly dipping following the August inflation report. The 10-year bond yield was 4.95% around midday, just 5 basis points from the important 5% threshold that's represented a danger zone for stocks. It briefly spiked to 4.99% earlier in the day.

What makes 5% such a feared threshold among investors?

There's nothing inherently catastrophic about the number itself, but 5% has become the level to watch largely because the 10-year yield has rarely broken through that threshold in recent history, Padrhaic Garvey, the regional head of research, Americas, at ING, told Business Insider.

Beyond a short-lived bond market freakout in 2023, the last time the 10-year yield rose past 5% was in 2007, in the months leading up to the start of the Great Financial Crisis.

"Traders look at round numbers, and above 5% means that the next stop could be 5.5% and 6%," Jose Torres, a senior economist at Interactive Brokers, said. "And in this post-Great Financial Crisis economy, it's not a yield that's tolerable for financial markets."

The 20-year and 30-year yields have already breached the 5% mark, but the 10-year, which most directly influences borrowing costs like mortgages and corporate loans, tends to have more "gravitas" in the eyes of investors, Torres added.

5% means higher borrowing costs

Markets also consider higher borrowing costs a negative in and of themselves. The 10-year yield hitting 5% immediately draws attention to higher mortgage rates and higher funding costs for businesses, Garvey says.

The average 30-year average fixed mortgage rate was 6.76% in the last week, according to Freddie Mac data. The rate has increased 60 basis points this year, marching higher alongside the 76 basis-point rise in the 10-year bond yield.

The effective yield on the ICE Bank of America US High Yield Index, a reflection of corporate borrowing costs, also rose to 7.42% in the last week, up 89 basis points since the start of this year.

The 'danger zone' for stocks

Higher yields have also historically stoked fears about the impact of higher rates on risk assets, like stocks. In a note to clients earlier this year, HSBC said it believed yields were solidly in the "danger zone" when it came to the impact on equities.

"If we were to break above 5%, it would cause stresses. It absolutely would. It could potentially cause the risk asset space to fall over," Garvey said, though he noted that the speed at which yields increased mattered more to the impact on stocks than the actual yield itself.

The speed at which the 10-year rose from the 4.5% mark is worrying, he added.

"You could argue that, isn't it about time that the market uses it as an excuse to claw back some of that and pull back from highs?" Garvey said.

5% means Treasurys could crowd out corporate debt

Finally, yields hitting 5% also fuels concerns that Treasurys will start competing with corporate bonds, which could have negative implications on the AI boom, which is being financed in large part with debt, Torres added. Higher borrowing costs could skew the economics for AI companies plowing money into the technology at a time when investors are already concerned about the return on soaring capex.

"The AI firms need so much money to build out that infrastructure that they're literally competing with the Treasury for fixed income investors," he said.

Torres said the pressure on government bonds was intense, given ongoing fiscal and inflation concerns. The only things that could meaningfully lower yields at this point are a long-term resolution with the Iran war, or the Fed beginning substantial quantitative easing, such as by adding around $50 billion worth of Treasurys to its balance sheet, he speculated.

Padhraic said he saw the potential for yields to climb to 6% in the near future, which would mark the 10-year's highest yield since 2000.

"The danger period of going from 5% to 6%, if that was to happen in the next couple of months, it would be something quite difficult for the market," he said of that risk scenario.