The one thing in markets everyone should be watching

• The 10-Year US Treasury yield is arguably the most important thing to watch right now for investors.
• The 10-Year yield has soared to levels not seen since 2007, and that's having a big impact on stock prices.
• Here's what you need to know about what bond yields are doing to markets and the economy. 

Surging bond yields have left their mark on the stock market in recent weeks, and the 10-Year US Treasury yield has become arguably the most important thing for investors to watch. 

The 10-year hit a cycle-high of 4.88% on Wednesday, representing its highest level since August 2007. It's surged from 3.75% at the start of the year, and just 1.61% two years ago.

Investors are scrambling to understand just how much higher the key government bond yield can go from here.

That's because rising bond yields can have an outsized impact on the economy, and the phenomenon has been a double whammy for investors, particularly those that rely on the popular 60% stock and 40% bond portfolio allocation. The 10-year Treasury also influences the rate on a range of consumer loans, including mortgages. That means investors aren't the only ones who feel the impact, but also ordinary Americans. 

Legendary investors including Ray Dalio, Bill Ackman, and Bill Gross all see the key bond yield hitting 5%, which would mean another big rise from current levels. 

Here's what that means, and why all eyes should be on the 10-year US Treasury. 

Higher yields = bad for the stock market

Higher interest rates and rising yields is a key reason why JPMorgan's top equity strategist has been bearish on stocks all year.

"Our cautious outlook will likely remain in place as long as interest rates remain deeply restrictive," JPMorgan's Marko Kolanovic said in a recent note.

Opportunity cost is a top consideration for investors, and when interest rates were near 0% for more than a decade, investors had little choice but to pile into stocks.

Now, the equation has changed. Investors today can earn just over 5% holding risk-free government bonds and other cash equivalents, an enticing proposition when compared to the high-risk stock market's average annual return of about 7% after inflation.

That's why cash has poured into money market funds and short-term bond funds over the past year, money that in times of lower yields likely would have flowed into stocks. 

JPMorgan's Kolanovic is warning clients that the stock market carnage isn't over as long as interest rates and bond yields are elevated, comparing today's situation to the run-up to the 2007 crash. 

"What we find remarkable is that going into the crisis in 2007, investors were discussing the exact same topics as today: Fed pause, consumer resiliency, soft landing, strong jobs, etc.," Kolanovic said.

Higher yields = bad for the bond market

It's not just stocks. Rising bond yields are also thrashing the bond market, as bond prices fall when yields rise.

Think about it: long-duration bonds purchased during a zero-interest rate world are now a lot less valuable than long-duration bonds that are offering a 5% interest rate.

That's why the iShares 20-year US Treasury Bond ETF has seen volatility on par with equities in recent years, falling 52% from its 2020 peak.

And US Treasury bonds are on track to deliver three consecutive years of negative returns, something that has never happened in the country's history.

The positive correlation between stocks and bonds over the past year has put a lot of strain on the most popular investment portfolio: the 60% stock and 40% bond allocation.

Investors have been conditioned to expect bonds to perform well when stocks perform poorly, helping limit portfolio volatility. That relationship has been turned upside down since the Fed started hiking interest rates aggressively 18 months ago, with both bonds and stocks falling in tandem. 

The 60/40 stock bond portfolio fell 16% in 2022, representing its worst annual return since 2008.

Higher yields = bad for the economy

Rising interest rates have helped push Treasury yields up, which in turn have driven up costs for a range of consumer loan products. 

This has the effect of slowing down the economy over time, as it increases the cost of borrowing for big purchases like cars and homes.

Home purchases are especially important because they serve as an economic multiplier. New home buyers often spend a lot of money on other goods and services, which in turn stimulates the economy. 

But with the average 30-year mortgage rate approaching 8%, the cost of owning a home is becoming prohibitive for more and more consumers, and home sales have come to a screeching halt.

Higher interest rates also means higher credit card rates, leading to a rise in delinquencies in recent months. 

"High mortgage rates, high car rates, high credit card rates — they're starting to have an impact on the economy," Pershing Square CEO Bill Ackman recently told CNBC.

Higher rates (and higher yields) are a delicate balancing act. A steadily rising interest rate over a long enough period of time can be manageable for the economy, as it gives consumers and businesses more time to adapt.

But a sharp and sudden rise, as we've seen over the past month with the 10-Year US Treasury yield surging 65 basis points, can catch the economy off guard and lead investors to panic about something "breaking" in financial markets.