Treasury yields: Here’s why investors need to watch them closely

Investors in equity markets need to watch various signals from other asset classes and treasury yields are one of them. In this article, we explain why.

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Why Treasury yields matter

Making a Long story short

Treasury yields matter to investors because they act as the reference point for pricing risk, time, and return across all financial assets. Government bonds are treated as the closest thing to a risk-free investment, so their yield become the baseline return investors can earn without taking on credit risk.

Every other asset, including shares, must justify why it deserves to earn more than that baseline. When treasury yields move, they change the minimum return investors require from equities, which directly affects valuations.

Treasury yields influence DCFs

From a valuation perspective, treasury yields feed into the discount rate used to value future cash flows in DCF methodologies (one of the most popular ways to value companies.

Whether an investor is explicitly running a discounted cash flow model or implicitly relying on valuation multiples, higher yields mean future earnings are discounted more heavily. This reduces the present value of those earnings and pushes down share prices.

This effect is much stronger for companies whose profits are expected far into the future, such as growth and technology stocks, because a larger portion of their value comes from distant cash flows. When yields fall, the opposite happens: discount rates decline, valuations expand, and growth stocks often outperform.

Invest in equities, or other asset classes?

Treasury yields also influence how investors allocate capital between asset classes.

When yields are very low, bonds offer unattractive returns, pushing investors toward equities in search of income and growth. This environment tends to support higher equity valuations because there are few alternatives.

When yields rise, government bonds start to offer competitive returns again. Investors are then forced to reconsider whether taking equity risk is worthwhile, especially for companies with low profitability or uncertain earnings. This competition for capital can lead to money flowing out of equities and into bonds, putting downward pressure on share prices.

Not all sectors respond the same

Different sectors respond differently to changes in treasury yields. Rising yields tend to hurt sectors that behave like long-duration assets, such as technology, infrastructure, and property, because their valuations depend heavily on stable, long-term cash flows.

At the same time, higher yields can benefit financials like banks and insurers, which may earn higher margins or reinvest premiums at better rates. As a result, changes in yields often drive rotation within equity markets rather than uniform moves up or down.

A signal for the economy

Treasury yields also act as a signal about the broader economy. Rising yields can reflect stronger growth expectations or higher inflation, while falling yields often indicate concerns about economic slowdown or recession.

Equity markets respond not just to the level of yields, but to the reason they are moving. Yields rising because growth is accelerating can be compatible with rising share prices, while yields rising due to persistent inflation and tighter monetary policy are more likely to pressure equities.

They influence companies

Finally, treasury yields influence companies directly through their cost of capital. Higher yields translate into higher borrowing costs, which raise interest expenses, reduce profitability, and make investment projects less attractive. This can slow capital expenditure, reduce merger activity, and constrain buybacks and dividends. All of these effects feed back into equity valuations.

A concrete example

Imagine two companies. Company A is a mature industrial business expected to generate steady cash flows of $100 million per year for the next 10 years. Company B is a high-growth technology company expected to generate minimal cash flow today but $300 million per year starting in year 8 and beyond.

If the risk-free rate is 2%, investors might discount these cash flows at, say, 7% for Company A and 9% for Company B. Under those assumptions, both companies might look attractively valued. Now suppose the 10-year treasury yield rises from 2% to 4%. The discount rates rise to 9% and 11% respectively.

The present value of Company A’s near-term cash flows falls modestly. The present value of Company B’s distant cash flows falls dramatically. Even if nothing about either company’s operations has changed, Company B’s share price is likely to drop much more. This is why growth stocks are often described as “long-duration” assets and are especially sensitive to yield movements.

Can markets fall even when yields fall?

Yes they can. Falling yields are not always good news for equities because they often reflect deteriorating economic expectations rather than easier financial conditions.

When yields fall due to fears of recession, investors expect lower corporate earnings, higher default risk, and weaker demand. In that situation, the positive effect of a lower discount rate can be overwhelmed by falling earnings expectations and rising risk premiums.

Investors may demand a higher equity risk premium to compensate for uncertainty, which can push share prices down even as yields decline. In extreme cases, falling yields coincide with sharp equity sell-offs as capital moves into government bonds as a safe haven.

So what does this mean for ASX investors?

In the Australian market, changes in global and domestic bond yields have clear and observable effects. The major banks tend to benefit when yields rise moderately because higher interest rates can expand net interest margins, especially if loan growth remains healthy. However, sharply rising yields that threaten economic growth can still hurt bank share prices due to concerns about credit losses.

ASX-listed REITs and infrastructure stocks, such as toll roads and utilities, are typically very sensitive to yield movements. These businesses are often valued for their stable, bond-like cash flows, so rising yields reduce their relative attractiveness and compress valuation multiples. When yields fall for benign reasons, these stocks often outperform.

Growth stocks on the ASX, particularly in technology and healthcare, tend to behave like their global peers. Rising US treasury yields often pressure Australian growth stocks even if local conditions are stable, because global investors price these companies using global discount rates.

Finally, resource stocks sit somewhat apart. Their performance is often driven more by commodity prices and global growth expectations than by discount rates alone. Rising yields driven by stronger global growth can actually support miners, while falling yields driven by recession fears often hurt them.

Conclusion

Even if you never own a bond, Treasury yields: shape valuation multiples, drive style rotation (growth vs value), signal macro turning points and influence earnings sustainability. They’re essentially the gravitational field that equity prices move within.

So keep watch!