U.S. Treasury yields have risen sharply in recent weeks, with the 10-year note approaching levels not seen since early 2024. The surge in yields reflects growing concerns across financial markets about the sustainability of U.S. fiscal policy, the threat of renewed inflation, and the weakening demand for U.S. government debt.
As borrowing costs increase, the impact is being felt not only in bond markets but also across the stock market and the broader economy. This shift in yields is altering how investors think about risk, particularly through the lens of the equity risk premium, and is tightening financial conditions for consumers and businesses alike.
A primary driver of rising bond yields is the rapid deterioration in the federal government’s fiscal outlook. Washington has introduced a sweeping multi-trillion-dollar economic package known as the “One Big Beautiful Bill Act.”
The proposal includes deep tax cuts and large-scale infrastructure, energy, and defense spending. Early projections suggest the total cost could exceed $3 trillion over the next decade, potentially pushing the U.S. debt-to-GDP ratio to 125% by the early 2030s. With government expenditures continuing to outpace revenues, markets are increasingly concerned that the U.S. fiscal path is becoming unsustainable.
These concerns were underscored on May 16, 2025, when Moody’s downgraded U.S. sovereign credit from Aaa to Aa1, citing ballooning deficits, rising interest burdens, and Washington’s growing political paralysis. As the Treasury ramps up issuance to fund larger deficits, the increased supply of bonds must be met with sufficient demand.
If investors—particularly institutional buyers like pension funds, foreign central banks, and insurance companies—become skittish, the government must offer higher yields to entice them back to the auction table. That’s exactly what happened during the most recent 20-year Treasury bond auction, which was poorly received and forced the Treasury to accept higher yields than anticipated to clear the offering. The weak demand for long-duration debt suggests that markets are demanding greater compensation for holding U.S. paper in light of the fiscal and inflationary risks ahead.
Adding further upward pressure on yields are the tariffs increasing production costs for U.S. businesses and raising prices for consumers, especially for goods that are difficult to source domestically. As companies pass these costs through the supply chain, inflationary pressures intensify. Investors in the bond market, sensitive to any signs of inflation erosion in the value of fixed interest payments, demand higher yields to preserve real returns.
The impact of rising yields does not stop at Wall Street. It is already being felt in households and businesses across the country. Because many consumer and corporate borrowing rates are directly or indirectly linked to the U.S. Treasury yields, higher government bond yields push up the cost of financing for everything from mortgages and auto loans to business credit lines.
The average 30-year fixed mortgage rate, which is closely tethered to the 10-year Treasury yield, is approaching 7%, putting homeownership further out of reach for many Americans. Car loan rates and credit card APRs have also surged, making big-ticket purchases more expensive and discouraging consumer spending.
On the business side, firms that rely on debt financing to fund capital projects or expand operations are now facing a higher cost of capital, leading to postponed investment decisions and tighter hiring budgets. Commercial real estate has been hit hard, as cap rates adjust upward in response to climbing yields, compressing valuations and reducing transaction activity.
At the center of the stock market’s anxiety is the shrinking equity risk premium (ERP), a critical measure of how attractive stocks are relative to bonds. The ERP represents the additional return investors expect from holding equities instead of government securities.
In essence, it compensates investors for the extra risk of owning stocks, which are more volatile and less secure than government bonds. The ERP is typically calculated as the difference between the expected earnings yield of equities—most often proxied by the forward earnings yield of the S&P 500—and the prevailing yield on 10-year Treasury bonds.
As of May 2025, the S&P 500 forward earnings yield approximately 5.2%—trailing yield is lower—, while the 10-year Treasury yield has climbed to 4.6%. This puts the equity risk premium at a mere 0.6%, far below its historical average range of 3% to 5%. A premium this low indicates that investors are barely being compensated for the risks associated with equity ownership. In other words, they are taking on substantial market volatility, policy risk, and earnings uncertainty for almost no additional reward compared to safe Treasuries.
The consequences of such a narrow risk premium are twofold. First, it leads institutional investors—such as pension funds, endowments, and insurance companies—to reallocate portfolios away from equities and into fixed income, particularly now that bonds offer yields not seen in over a decade. This rebalancing puts downward pressure on stock prices, especially in sectors like technology and real estate that are sensitive to interest rate changes.
Second, a low ERP increases market vulnerability. With little cushion to absorb earnings disappointments or geopolitical shocks, even minor negative surprises can result in outsized equity sell-offs. Compounding this vulnerability is the fact that rising yields also increase the discount rate used in valuing future corporate earnings, which reduces the present value of expected cashflows and lowers stock valuations.
In short, the rise in bond yields is reshaping the entire risk-reward framework for investors. The forces behind this shift—escalating deficits, a sovereign credit downgrade, rising tariffs, and inflation concerns—are structural rather than temporary. They reflect deeper tensions in fiscal governance, global trade relationships, and investor confidence in the U.S. financial system.
Unless policymakers act decisively to restore fiscal credibility and stabilize inflation expectations, bond yields are likely to remain elevated. This would continue to suppress the equity risk premium, constrain credit growth, and weigh on economic activity. For now, the message from the bond market is clear: the cost of capital is rising, and with it, the risks of holding equities in an increasingly uncertain environment.
By Sung Won Sohn
The author is professor of finance and economics at Loyola Marymount University and president of SS Economics. He was executive vice president at Wells Fargo Banks and senior economist on the President’s Council of Economic Advisors in the White House.
