The cost of capital is rising. Did stocks get the memo?

Now add in ~$315 billion of expected bond market issuance from the hyperscalers in 2027 (on top of $280 billion in 2026), ongoing conflict in the Middle East and its effects on energy prices and a booming equity market. Whereas the Fed may have initiated the move higher in interest rates, it is no longer acting alone. The interaction between these other forces is increasingly shaping the direction of real yields, which may end up proving more important than the next 25 basis points from the Fed.

Not just the Fed

Even in the face of a historic stock market rally and bond market pivot, the most consequential move in financial markets may just be in the relentless rise in real yields. Representing the true cost of capital by accounting for inflation, this has the most direct impact on businesses, consumers and governments alike. Whereas a hawkish Fed has increasingly taken a back seat in driving bond yields, other factors have pushed to the front:

• The U.S. economy has been surprisingly difficult to slow. Rather than collapsing under the weight of higher interest rates and energy prices, U.S. economic activity remains relatively resilient. Consumers are still spending.
• Extraordinary demand for capital. Artificial intelligence infrastructure, data centers, semiconductors, power generation and grid modernization are absorbing large amounts of investment. A stronger investment cycle paves the way for longer-term productivity.
• Competing for funds. The U.S. government is issuing large quantities of debt, putting Treasury supply in direct competition with private-sector investment demand. Bond investors have more choices of who to lend to.
• Energy prices continue to rise. The ongoing conflict in the Middle East and elevated commodity prices across the world means investors are demanding additional compensation for owning longer-duration assets that are subject to the uncertainty.

Taken together, the result is simple: The cost of capital is rising. The last comparable move was in 2023, when 10-year real yields rose nearly 90 basis points in less than a year as investors repriced growth, fiscal deficits and the prospect of a higher-for-longer interest rate environment. That episode ultimately pressured equity valuations, but stronger earnings helped cushion the impact. We’re seeing something similar happen today.

A bigger buffer

At first glance, an over 70 basis point rise in real yields should have been problematic for equities. In theory, when real yields rise, borrowing becomes more expensive for consumers and businesses. Over time, that can slow spending, investment and corporate earnings growth, creating a headwind for stocks. And when real yields rise by that margin in a span of months, it can often weigh on equity returns.

Yet stocks have remained unusually resilient. That’s because of corporate earnings, stronger economic growth and AI-related investment spending. Higher real yields can pressure equity valuations lower, but strong profit growth is proving to be an offset. After all, S&P 500 margins at 17% mark an all-time high.

One way to see this is through the S&P 500 equity risk premium, a simple measure of how much more investors are compensated for owning stocks rather than a 10-year Treasury bond. Bonds have naturally become more attractive as yields continue to climb. But so have equities, as multiples have compressed. As such, the equity risk premium is roughly where it began the year. In other words, on a relative basis bonds are no more attractive to equities on this framework despite the significant rise in real yields.