Treasury Yields Hit 5%: Why Software Stocks Could Be Your Best Bet

Key Takeaways

Table of Contents

The 10-year Treasury yield momentarily surpassed 5% for the first time in 19 years before settling at 4.994%
Traders are pricing in an 89.5% probability of a 25 basis point Federal Reserve rate increase this Wednesday
Nicholas Colas from DataTrek Research argues that 5% yields don’t pose a significant risk to equities
Software, energy, and financial sectors emerge as Colas’s preferred investment areas
Treasury Secretary Scott Bessent attributes yield increases to worldwide economic factors rather than domestic concerns

The benchmark 10-year U.S. Treasury yield made headlines this week by momentarily surpassing the 5% threshold—a level last witnessed in 2007—before moderating to approximately 4.994% by Wednesday morning. This significant movement has created unease across financial markets and captured widespread investor attention.

This surge occurred just before a critical Federal Reserve policy meeting, where market participants are assigning an 89.5% probability to a quarter-point rate increase, based on CME Fedwatch analysis. Such an action would elevate interest rates to their highest point in twelve months.

Multiple factors have contributed to the recent yield escalation, including persistent inflationary pressures, climbing oil prices, and more aggressive rhetoric from Federal Reserve policymakers. However, the yield rally experienced some moderation following disappointing manufacturing data from New York, which heightened worries about economic momentum.

Market participants have also reversed course, returning to bond purchases after an extended period of selling pressure, which has helped moderate yield increases somewhat.

Understanding the Forces Behind Rising Yields

Nicholas Colas, who co-founded DataTrek Research, identifies real yields as the fundamental catalyst behind this movement. Real yields recently settled at 2.55%, representing the highest reading since the 2008 financial crisis, though remaining beneath the 3.06% zenith reached in November of that year.

According to Colas, ongoing government expenditure represents a critical element. Given that the United States maintains a deficit ranging between 5% and 6% of GDP, continued fiscal expansion continues to fuel inflationary pressures and compels bond market participants to demand higher compensation.

The Treasury market, in Colas’s view, is fundamentally demanding yields above 5% as compensation for risks associated with a Federal Reserve maintaining rates around 4% combined with deteriorating creditworthiness relative to ten years ago.

During congressional testimony this week, Treasury Secretary Scott Bessent characterized rising yields as connected to international economic dynamics. He simultaneously recognized the importance of tackling America’s expanding fiscal imbalance and supported the Treasury’s approach of increasing long-duration debt repurchases.

Implications for Equity Markets

Notwithstanding widespread concern surrounding 5% yields, Colas maintains that equity markets face no substantial threat. His analysis suggests that robust corporate profit expansion is counterbalancing pressures from elevated discount rates, eliminating the necessity for valuation multiple compression.

He characterizes the present situation as markets effectively performing the Federal Reserve’s function by decelerating economic activity and reducing inflationary forces, rather than indicating systemic distress.

Within this context, Colas identifies software stocks as significantly undervalued relative to semiconductor companies, presenting an attractive entry point. Energy and financial sectors also feature prominently among his recommended positions.

Financial stocks had previously experienced downward pressure amid speculation that Treasury Secretary Bessent might implement measures to constrain long-dated bond yields, but such intervention has not materialized, while earnings estimate revisions for the sector remain constructive.

The critical consideration moving forward is whether sustained 10-year yields near 5% will prompt Treasury officials to implement additional intervention strategies aimed at suppressing rates.

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