The S&P 500 is eyeing a new record. Why the bond market still holds power.

The index appears rich: Investors are still paying a nearly three-year-high multiple for anticipated future profits, making stocks particularly vulnerable to negative surprises. U.S. economic growth has been sufficient, but tariffs, along with geopolitical conflicts in the Middle East and elsewhere, raise the specters of higher prices and slower growth—which could spur stagflation. Analysts are worried that such a scenario could negatively hit company profits as consumers spend less.

The bond market, meanwhile, has gotten lost in the list of market worries. Investors should pay attention—they may still pack a punch.

True, bonds haven’t done much in June. The yield on the 10-year Treasury note has oscillated in a 25-basis-points range over the last 20 trading days, the smallest range over a one-month period since fall 2024, wrote BMO Capital Markets strategists Vail Hartman and Ian Lyngen in a note.

If the yield on the 10-year pushes much higher, stock prices are expected to take a hit: When yields are elevated, investors often move money to bonds, which are less-risky and offer better returns. But it doesn’t need to always play out that way.

The stock market’s reaction to bond yields will be driven by the underlying reasons for the rise, not just the absolute yield numbers. Higher yields due to better-than-expected economic growth are good news for companies’ profits, and in turn, their stocks.

However, higher yields due to more term premium—which measures the extra yield investors demand to stash away money for a decade, rather than just repeatedly investing in short-term securities—signal economic uncertainty and can hurt stocks. Term premium is now adding 70 basis points onto the yield for the 10-year.

Term premium is driven by myriad factors, including market supply and demand for bonds, central bank policies, and uncertainty about government regulations. The relative impact of each of these factors is hard to measure and can shift over time.

Term premiums are not observable and cannot be traded. People have models for rough bearings, but there’s inherent uncertainty around the estimates, wrote Benson Durham, Piper Sandler’s head of global policy and asset allocation, in a Wednesday note.

Wars, for example, increase the supply of U.S. Treasuries—but investors will find the supply less threatening if there’s demand for these notes. If the demand from investors looks weak, the term premium will move higher at some point to reflect this mismatch in supply and demand.

“There’s certainly a threshold that we think of with regard to how big those negative supply shocks have to be to for these things to get priced immediately, which I think would be a serious bear market in equities, and would cause a genuine rise in term premium,” Freya Beamish, Chief economist at TS Lombard, told Barron’s

Uncertain economic policies that change too quickly can also raise term premium—especially if more slow-moving investors like pension funds and insurers, who plug in money on longer-dated bonds, retreat.

“My point is this—if you want an answer as to how [5% yield on the 10-year Treasuries] might affect the S&P 500, much more background is required, even if a story, Durham wrote. “And no one can ever be too sure.”

Write to Karishma Vanjani at  [email protected].