Yields Hit 5%, Rates Hiked, as AI Fervor Cools

Every morning before the opening bell, the Schwab Market Update sets the stage for the day ahead, covering key market movers, economic developments, and emerging themes. Each edition includes "Three things to watch" while Thursdays feature a weekly section, "Crypto currents." This recap revisits select items for those who may have missed them, helping traders head into the weekend better informed.

Though major indexes slid into Wednesday's rate decision and lost more ground afterward, the S&P 500^® Index was down just 2.4% from all-time highs after Thursday's rally. The index has basically treaded water since June, hurt by rising yields and oil prices, but staying afloat thanks to exuberant earnings across Wall Street. To some extent, major indexes reflect hopes that earnings will keep climbing even with tougher comparisons ahead. The wild card is the Fed. If rates climb as high as CME futures trading suggests by mid-2027—to well above 4%—earnings estimates could fall as borrowing costs rise. The market's path also depends on the pace of hikes. "If we see the Fed adopt an escalator response—hiking rates in small increments, perhaps at every other meeting—stocks should be able to digest the relatively slow tightening process," said Kevin Gordon, head of macro research and strategy at the Schwab Center for Financial Research, or SCFR. "This is consistent with history, as the S&P 500 has, on average, moved up by 10.5% in the year after the start of a slow tightening cycle."

Despite expectations for an increase, U.S. crude oil inventories fell 600,000 barrels last week to 423.4 million, the government said. Gasoline demand dropped 1% year over year to 8.8 million barrels a day. That's roughly the same gasoline demand the United States averaged 25 years ago, and down from record highs near 10 million in 2019. Lower gas demand this century reflects many factors, including more people working at home, efforts by transport companies to improve efficiency, and the popularity of hybrid and electric vehicles. Hybrids accounted for a record 14% of U.S. auto sales in the first quarter, according to researcher Cox Automotive. All this is great for companies overseas that dominate hybrid manufacturing, but only one of the top 10 biggest selling hybrids is made by a U.S. company. Ford (F) sells the most hybrids of any U.S. manufacturer and has said nearly all its vehicles will have a hybrid or multi-energy powertrain choice by the end of this decade. However, hybrids come with a higher cost of entry for consumers strapped by rising interest rates.

All things considered, crypto is holding up well. Bitcoin fell only 3.3% on Tuesday, after the U.S. Senate blocked advancement of the Clarity Act, a market-structure bill that many investors had hoped would trigger a crypto rally upon passage. Though failure to advance the act does remove a potential catalyst—at least for now, it could pass later—passage has never been priced into the market, which explains the relatively muted response, said Jim Ferraioli, director of digital currencies research and strategy at SCFR. Still, coins on other blockchains that are being used to innovate within the traditional financial system, such as through asset tokenization, may feel a bit of a drag over time due to a lack of improved regulatory clarity, Ferraioli said. "The genie is out of the bottle—crypto isn't going away—but further delays on crypto regulation could impact multi-year crypto roadmaps," he said.

The 10-year Treasury note yield hit 5% on Monday for the first time since late 2023, a level it hadn't closed above since 2007. While higher yields raise borrowing costs and make home buying tougher, 5% is historically around average. It may merely seem high to those accustomed to near-zero rates for a decade after the financial crisis of 2008 and after Covid. The 5% mark is also roughly where yields were around the time of the internet collapse 26 years ago, but the 5% yields didn't cause that sell-off. Yields had been falling from even higher levels, meaning the internet rally occurred with yields generally above where they are now. That's a reminder that there's nothing particularly spooky about current levels. Also, yields haven't dented the labor market in a material way. "Treasury yields might not be a problem that needs to be fixed," said Collin Martin, head of fixed income research at SCFR. "They are indicative of the economic environment we're in," he explained, noting that nominal economic growth has remained robust and inflation remains well above the Fed's 2% target.

It's more than a month until Halloween, but the tech sector has been spooked this week by worries about possible dire scenarios associated with AI. Early last year, the sector shuddered after China's Deep Seek AI model was introduced, raising competition worries. It was short-lived but still sent the PHLX Semiconductor Index (SOX) down 9% quickly. From that low to the June 2026 high, the SOX gained more than 200%, though fears of Chinese competition haven't vanished. Chip stocks suffered another speed bump last year when President Trump announced tariff "liberation day." Things haven't been great lately for the SOX, however, as it approached Monday's session down about 19% from the all-time high three months ago and has slumped about 1% throughout the week. The difference now is the time of the quarter. The previous selloffs came in January and April 2025, just as earnings season was starting and companies could tout strong results and guidance. This time, it's a major earnings lull and none of the AI and chip companies have reports scheduled for a while. The fear is that this new scare might slow spending on data centers, chips, and computer equipment that's been a dramatic tailwind for the entire market and economy since 2022.