Rising long-term yields pressured markets last week, yet the broader bull run in equities may persist provided growth fundamentals hold, according to a UBS market strategist.
Over the week, the U.S. 10-year Treasury yield moved up from 4.4% to 4.6%, creating a wider gap between the 10-year and the two-year yield - a pattern known as a bear steepener, where long-term yields climb faster than short-term yields. Markets are pricing in roughly 0.6 rate hikes by December, the strategist noted.
UBS attributed the yield shift to two main forces. First, oil prices rose after President Trump’s visit to Saudi Arabia failed to settle concerns around the Strait of Hormuz. Second, the move reflected a spillover from U.K. rates, which spiked amid a domestic leadership crisis.
Despite those pressures, the strategist argued that the equity bull market rests on three substantive pillars. The first pillar is sustained fiscal support: the world’s four largest economies - the U.S., China, Germany and Japan - remain in fiscal expansion mode and together account for more than half of global GDP.
The second pillar is resilient consumer demand. U.S. retail sales increased by 0.5% month-over-month in April, an indicator that households continue to spend.
The third pillar is corporate investment, particularly spending on AI infrastructure. Data center capital expenditure is now running at about 2.5% of U.S. GDP and continues to rise, underscoring strong demand for compute capacity.
"So governments, consumers, and corporations are spending," the strategist said in a note.
The strategist acknowledged that higher rates could apply some marginal pressure to consumer spending as mortgage rates move up. However, she argued that such increases are unlikely to reverse government outlays that have already been approved by legislative bodies or to cause corporations to back away from AI-related capital projects.
"The demand for compute is already withstanding very high electricity prices. And hyperscalers are not blinking when paying rates that can come in at a substantial premium to base rates. So growth is likely to remain strong in the short term," the strategist wrote.
On the relationship between Fed policy and equities, the strategist noted that sustained sequences of rate hikes have historically been a prerequisite for significant equity market weakness. She pointed to May 2000, when a sixth consecutive 50 basis point hike accelerated the Nasdaq’s decline. By contrast, the central bank is not currently in a hiking cycle and the official language still signals an easing stance.
Real yields are another focal point. The strategist highlighted a historical threshold of 10-year real rates in the 2.0%-2.5% range as noteworthy, and observed that real rates are currently close to the 2.0% mark.
Importantly, a bear steepening of the yield curve has not proven to be a reliable early warning of an equity selloff in past episodes; on average, such steepenings have been followed by positive equity returns, she added.
"Higher rates do not derail bull markets when growth remains strong," the strategist concluded, while conceding that markets could experience short-lived drawdowns as they adjust to a higher rate environment before resuming an upward trend.