The bond market reached a tipping point this week when the 10-year U.S. Treasury yield touched 5%: Either the key benchmark has reached its ceiling, or it is just getting started with a new era of higher borrowing costs.

The 10-year yield helps set rates on everything from mortgages to corporate loans, and its recent rise has added to the list of challenges confronting the economy and the stock market. Before this week, it had only touched 5% once since the 2008 financial crisis, during a single trading session in 2023. But it did so again Monday and touched a new 19-year high on Tuesday, sending major stock indexes lower for the second straight session.

"Higher yields are definitely weighing on stock sentiment," said Michael Antonelli, a managing director at Baird.

The 10-year's path from here will be paved by the Federal Reserve, economic data, military conflict and even the stock market itself.

Fed policy

The 10-year yield breached 5% just before a meeting of the Fed's rate-setting committee, often a catalyst for major moves in the bond market.

Treasury yields, which rise when bond prices fall, typically move with investors' expectations for the short-term rates set by the Fed. But what that means for the 10-year Treasury now is unclear.

Generally, expectations for higher rates will push up yields on even longer-term bonds. But not always. They might stay the same or even decline if investors think those rates will slow the economy or curb inflation.

Right now, investors already expect the Fed to raise rates on Wednesday, and interest-rate futures show a good chance of at least three more hikes by the end of next July. That is already a steep enough path that some investors believe that a further step-up in rate expectations could at least contain the selloff in longer-term bonds.

"Fed hikes should slow the run-up in 10-year Treasury yields by reinforcing the Fed's determination to get inflation back down to target and by pumping the brakes on the economy," said Don Ellenberger, head of multisector strategies at Federated Hermès.

Growth, inflation and oil prices

Ultimately, how rate expectations affect the 10-year yield largely depends on investors' take on the economy.

If investors are worried about inflation, yields are likely to climb no matter what-either because rates are rising now or because investors think they will need to go up in the future.

Right now, Wall Street is generally optimistic on growth and pessimistic on inflation, creating the ingredients for yields to stay elevated.

Bank CEOs this week said that borrowing demand has been strong from both consumers and corporations, even in the face of higher interest rates on loans. "The Fed will raise rates, but it won't knock the economy off its movement," Brian Moynihan, Bank of America's chief executive, said Tuesday at an investor conference.

The inflation outlook, meanwhile, is being heavily influenced by a jump in oil prices spurred by conflict in the Middle East. Brent crude, the international benchmark for oil, rose 2.9% to $108.75 Tuesday. The closure of a critical Saudi pipeline is pressuring supply, sending prices higher and stoking inflation fears.

Bond investors aren't just worried about how high energy prices can rise but how long they can stay elevated, said Kish Pathak, fixed-income research analyst at MFS Investment Management, because a lasting increase is more likely to feed broadly into consumer prices.

A stock selloff?

One of the wild cards for the bond market is what happens with stocks. So far this year, stocks and yields have mostly climbed in tandem. More recently, stocks have slipped while yields have continued to rise. But if stocks begin to fall sharply, analysts said, many investors could race into bonds and other safer assets, pushing yields lower.

Normally, rising energy prices could hurt the consumer by eroding inflation-adjusted earnings, but "what's swamped that is the wealth effect that is coming from the equity market," said Pathak.

If stocks slump-because of safety concerns about artificial-intelligence or anything else-that could hurt consumers and be "the start of the disconnect between oil and yields," he said.

The yield on the 10-year note settled at 4.995% Tuesday, after reaching as high as 5.041% in overnight trading. The Dow Jones Industrial Average fell 0.6%, or 328 points. The S&P 500 slipped 0.4%, while the Nasdaq composite slid 0.8%

The buyback conundrum

There is also Treasury Secretary Scott Bessent's expanded debt-buyback program. Last month, the Treasury Department said that it would attempt to at least double buybacks of longer-term Treasurys in what investors saw as a clear effort to drive down yields.

There are some signs that the initiative could be at least containing the rise in yields, as longer-term yields haven't climbed as much as short-term yields in recent weeks. Still, some think that it could be backfiring by raising expectations that can't be met.

Last week, the Treasury Department said it would buy up to $6 billion of 10-year to 20-year securities in a coming buyback operation, but bond yields rose in response, suggesting that investors had been expecting a larger purchase.

Then, they rose again the next day when the Treasury Department revealed that it had only bought back $5.2 billion, indicating that the government couldn't find enough offers at prevailing market prices to meet its target.

Six more buyback operations aimed at longer-term debt are currently scheduled through early November, and the Treasury Department has only said that the target for each will be at least $4 billion.