Rising Bond Yields Pose Risks to US Stocks and Boost Dollar

Higher bond yields are emerging as a key risk to US stock prices while providing short-term support for the dollar, according to analysts at BCA Research.

The yield on the 10-year US Treasury note surged above 4.7% this week, reaching levels unseen since April. This spike, driven by falling bond prices, has weighed heavily on major currencies, with the euro nearing parity and the pound briefly losing over 1%.

Investor sentiment took another hit following reports that President-elect Donald Trump may declare a national economic emergency to justify sweeping import tariffs. Despite Trump denying plans to limit tariffs to critical goods, concerns persist. Initially, investors welcomed the prospects of deregulation and tax cuts under Trump. However, fears that tariffs could reignite inflation, strain government resources, and restrict the Federal Reserve's ability to cut rates have grown.

BCA analysts, led by Arthur Budaghyan, anticipate 10-year Treasury yields could climb to 5%, a move that would increase corporate borrowing costs. This scenario could particularly hurt mid- and small-cap stocks, while elevated Treasury yields and frothy equity valuations leave US stocks increasingly vulnerable.

The US equity risk premium, a measure of the additional return investors expect for choosing stocks over government bonds, is currently "very depressed," according to BCA Research. Although US equities surged after Trump's November victory, the S&P 500 remained largely flat this week, signaling potential weakness.

The combination of rising yields, tariff concerns, and stretched valuations poses significant challenges to US markets. Investors will be watching closely as these dynamics continue to unfold.