The Yield Squeeze: How Rising U.S. Treasury Yields Reshape Equity Valuations and Bond Strategies

The U.S. Treasury market has become a focal point for investors in 2025, as yields on long-term bonds have surged to levels not seen in over a decade. This rise, driven by a confluence of factors including quantitative tightening, heightened inflation expectations, and fiscal uncertainty, has profound implications for equity valuations and bond portfolio strategies. As the 10-year Treasury yield climbed from 3.8% in early 2023 to over 4.5% by mid-2025, investors are recalibrating their approaches to navigate a shifting landscape of risk and return.

The Mechanics of the Yield Squeeze

The surge in Treasury yields is not merely a function of central bank policy but reflects deeper structural shifts. According to a report by T. Rowe Price, the term premium on U.S. Treasuries—a measure of the extra yield investors demand for holding long-term bonds—has risen from a historic low of -1.41% during the pandemic to a positive 0.49% by late 2024, aligning with pre-pandemic averages Bond Yields Rise: Warning on Inflation, Debt? | Morgan Stanley^[3]. Simultaneously, inflation expectations, as measured by the break-even rate, have climbed from 2.03% in September 2024 to 2.40% by January 2025, reflecting concerns over Trump-era policy risks and persistent price pressures Bond Yields Rise: Warning on Inflation, Debt? | Morgan Stanley^[3].

These trends are compounded by the Federal Reserve's ongoing quantitative tightening, which has reduced its balance sheet by over $1 trillion since 2023, and a surge in Treasury issuance to fund a growing federal deficit. As Morgan Stanley notes, the market is signaling unease about long-term fiscal sustainability, with the term premium acting as a barometer for investor sentiment Bond Yields Rise: Warning on Inflation, Debt? | Morgan Stanley^[3].

Equity Valuations Under Pressure

For equities, the rise in Treasury yields has created a dual challenge. First, higher yields elevate the risk-free rate, which is a critical input in discounted cash flow (DCF) models. As T. Rowe Price explains, this increases the discount rate applied to future earnings, particularly penalizing growth stocks whose cash flows are projected further into the future How will a rising 10-year Treasury yield impact other assets? | T. Rowe Price^[1]. Second, the relative attractiveness of bonds has risen, prompting capital reallocation from equities to fixed income. This shift has been evident in the underperformance of growth-oriented sectors such as technology and renewable energy, which have seen outflows as investors prioritize income-generating assets The Fed - The Treasury Tantrum of 2023 - Federal Reserve^[2].

Moreover, rising yields often signal macroeconomic turbulence. The 2023 "Treasury tantrum," for instance, coincided with a sharp sell-off in risk assets as investors priced in tighter monetary policy and weaker growth The Fed - The Treasury Tantrum of 2023 - Federal Reserve^[2]. In 2025, similar dynamics are emerging, with equity risk premiums widening as markets grapple with the possibility of a prolonged high-rate environment.

Bond Portfolios in a High-Yield World

For bond investors, the challenge lies in balancing yield-seeking opportunities with duration risk. Long-duration bonds, while offering higher yields, remain vulnerable to further rate hikes. Conversely, floating-rate loans and short-duration instruments have gained favor. T. Rowe Price highlights that floating-rate loans, with their variable interest structures and shorter maturities, are well-positioned to benefit from a rising rate environment How will a rising 10-year Treasury yield impact other assets? | T. Rowe Price^[1].

Investors are also rethinking diversification. Traditional 60/40 portfolios, which historically relied on bonds to hedge equity risk, now face a dilemma: higher yields mean bonds offer less downside protection. As a result, many are turning to alternative allocations, such as real assets (e.g., real estate, commodities) and hedge funds, to mitigate inflation and policy risks Bond Yields Rise: Warning on Inflation, Debt? | Morgan Stanley^[3]. Some are even adopting bearish calendar spreads on long-duration bond ETFs, betting on further yield increases Rising Treasury Yields Prompt Investors to Reassess Strategies …^[4].

The Path Forward

The current environment demands a nuanced approach. For equities, sector rotation toward value stocks and cyclicals may offer better alignment with a higher-rate world. For bonds, active duration management and a focus on credit quality are paramount. As the Fed's 2023 analysis underscores, the term premium is unlikely to remain elevated indefinitely, but its trajectory will depend on fiscal policy clarity and inflation progress The Fed - The Treasury Tantrum of 2023 - Federal Reserve^[2]. Until then, investors must brace for volatility and adapt their strategies accordingly.