Treasury yields hitting 5% may not break markets now — but the clock is ticking

The 10-year Treasury yield hit its highest level since 2007 on Tuesday, pushing borrowing costs deeper into territory that could expose some of the financial system's weakest links. The question for investors is increasingly not whether a 5%-plus yield causes something to break immediately, but where the strain will emerge if rates stay there, industry veterans said. Market experts echoed that a 5%-plus benchmark yield will expose vulnerabilities gradually, as higher borrowing costs work their way through housing, commercial real estate and heavily indebted companies. The biggest danger comes if rates stay elevated long enough to force borrowers that loaded up on cheap debt during the zero-rate era to refinance at sharply higher costs. "Note that 5% doesn't break anything on the day it arrives. It breaks things twelve to eighteen months out, when the refinancing must happen at the new rate," said Jack Ablin, chief investment officer at Cresset Capital. "The risk isn't the level we're looking at this morning, however, the longer we stay here, the more difficult things could get." Housing will likely be among the most vulnerable. With long-term Treasury yields surging, mortgage rates are approaching levels that could further erode affordability. "It will likely show up in housing first," Ablin said. With 30-year mortgage rates potentially approaching 8%, he said, existing homeowners with mortgages around 3% are unlikely to sell. That means the initial hit may be less a wave of defaults than a deepening freeze in transactions, hurting homebuilders, mortgage originators, title insurers, brokerages and home-improvement retailers. Molly Brooks, a U.S. rates strategist at TD Securities, also pointed to housing as particularly sensitive because higher long-end Treasury yields feed directly into mortgage rates. Banks, by comparison, may feel the pressure later, if prolonged high borrowing costs lead to deterioration among property or corporate borrowers, according to Leung. Over the short-term, a steeper yield curve can initially support lenders' margins as banks typically fund themselves at shorter-term rates and lend at higher rates further out the curve, Brooks said. The key issue is not necessarily today's yield level, but the fact that debt raised at 2%-3% now needs to be refinanced closer to 6%-8% in many cases," said Billy Leung, investment strategist at Global X ETFs. "That creates pressure on cash flows, asset values and credit quality." Many companies extended their debt maturities during 2020 and 2021 or subsequently pushed repayments further out, delaying the impact of higher rates. But "The critical point is that the maturity wall was moved, not removed," Ablin said. Ablin said he is watching interest-coverage ratios in leveraged loans and signs of strain in private credit, including a greater share of borrowers paying interest with additional debt rather than cash. Leung highlighted leveraged loans, speculative-grade credit, private equity-backed co...