When Do Higher Bond Yields Become a Problem for Equities?

This article first appeared in The Sunday Times on 27 September 2026

Ever since US Treasury Secretary Bessent intervened in the US government bond market in August, with his plan to increase bond buybacks, there has been a growing sense of unease in markets that rising bond yields are becoming problematic.

Certainly, for governments they are – they raise the cost of servicing debt and add to fiscal pressures. But for investors the big question is could rising yields derail the equity market rally? 

In 2022, US 10-year yields rose from 1.4% to 3.4% in the first three quarters, and the S&P 500 fell by just under 20%. Yet, since March of this year, bond yields have risen 1%, but equities are also up about 12%.

Why the seeming contradiction?

The reason is it matters why yields are rising. In 2022, higher inflation was forcing central banks to raise rates, and higher rates were expected to weaken economic growth.

The recent rise is different. For sure concerns about fiscal deficits and stubbornly high inflation have been part of the narrative, but strong economic growth and demand for capital have also been important drivers.

Despite significant shocks, like the imposition of tariffs last year and the war in Iran this year, economic growth in the US, and broadly around the world, has remained remarkably resilient.

In the US, the Federal Reserve lowered interest rates in 2025 on concerns that the labour market may be weakening, but this month they raised interest rates as growth now looks more robust and inflationary pressures remain. 

A big driver of economic growth, and of the rise in yields, is AI and the enormous capital expenditure that has come with it.

This year the largest tech companies, known as the hyperscalers, are expected to spend US$785bn on AI-related capital expenditure. That number is expected to rise to $1.16 trillion by 2030.

To put the capex boom in context, in the US, spending on IT equipment is now greater than the aggregate spending on residential housing development.

Only a few years ago the large tech companies were awash with cash, regularly buying back their stock. Now free cash flow is going on capex, and they are increasingly tapping financial markets to raise capital for further spending, putting upward pressure on yields.

At the same time rising capex is boosting not only economic growth and inflation but also company earnings. When Microsoft buys chips from Nvidia, the expenditure is an immediate revenue for Nvidia, but Microsoft’s expenditure is only depreciated over a number of years.

Multiply that example across the industry and it is easy to see why corporate earnings estimates have been ratcheted higher this year. In fact, equity market valuation measures such as price/earnings (P/E) ratios have come down despite rising stock prices, as earnings and earnings expectations have risen even more than stock prices.

The rise in stock prices also creates a favourable wealth effect (for holders of equities) which fuels further spending in the economy and reinforces the cycle.  

But all that doesn’t mean investors can be complacent.

Looking back through history we have seen multiple periods where equities initially rose alongside rising yields but ultimately corrected.

Most famously, in 1987, a hot US economy saw a boom in the stock market alongside rising bond yields. However, when yields touched 10%, a tipping point was reached, almost like a Wile E Coyote moment, when equity investors suddenly realised the size of the returns that were available in bonds, and equities crashed.

This time the magnitude of the rise in both yields and equities is more modest. In fact, the late 1990s rather than 1987 seems the most appropriate parallel. In the late 1990s we had a tech boom, soaring stock prices and talk of a bubble. The P/E ratio on the S&P 500 reached 30.

The difference this time is that the P/E ratio for the S&P 500 is about 22 – high but by no means extreme. But the question is whether earnings are sustainable or boosted by an exceptional capex surge. In effect we may be in an earnings bubble rather than a price bubble.  

How durable the boom will be is impossible to say. Spending on AI is being driven by the huge sense of opportunity around AI - what Keynes called animal spirits.  A modest rise in interest rates is unlikely to change that sentiment. But at some point if a meaningful return from the AI spend is not generated the willingness to fund capex could wane.

That leaves us with a scenario whereby the current outlook is positive, but the risks are obvious. The danger isn't simply that yields reach some magic number. It is that at some point capex slows and the earnings growth currently allowing equities to absorb higher yields begins to fade while yields remain elevated.

For investors that means building a portfolio that can continue to participate in equity gains as long as the boom continues, while balancing that with assets and strategies like bonds, gold and tactical strategies like trend following that can protect the downside for when the cycle eventually turns.

Yes, rising yields are a risk for equities, but the bigger risk is the durability of the AI capex cycle.

Alan Dunne is Founder and Chief Investment Officer at Archive Capital Advisors, and portfolio manager of the EPIC Archive Regime-Adaptive Fund.