The cost of capital and doing business in the American economy is sharply increasing.
Look no further than the rising yield on the U.S. 5-year Treasury note. It’s a benchmark that businesses of all sizes, from middle market firms to globally active corporations, use as they seek financing to expand or maintain their operations.
Since Feb. 27, the yield on the 5-year Treasury has increased by 157 basis points, from 3.50% to 5.07% on Sept. 28.
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One reason for the increase is that the 5-year Treasury is closely tied to the Federal Reserve’s policy cycle, which is turning toward tightening. The yields on longer-dated Treasuries like the 10- and 30-year Treasuries have increased as well as investors have priced in concern about the sustainability of the government’s fiscal path and elevated inflation.
But the spread between the 5-year and 10-year securities has narrowed, from an average of 33 basis points for much of this year to as low as 11 basis points in recent trading days.
In narrowing the spread, investors can cut their duration risk in half without giving up much yield by shifting toward the shorter end of the curve. That move should keep yields on the 5-year from surging but it still implies that the costs of doing business will continue to increase.
It’s why managers and executives should monitor the yield on 5-year Treasury notes to estimate the cost of short- and long-term corporate borrowing.
The increased cost of credit
The cost of unsecured short-term loans that cover the day-to-day funding needs for large corporations has jumped by 16 basis points to 4.16% since it became clear that the Federal Reserve would hike its overnight policy rate.
Short-term commercial credit is financed in money markets that are directly tied to the Fed’s overnight policy rate.
The market expects the Fed to follow its recent rate hike with a second increase before the end of the year, and then a third in the first months of 2027.
Commercial paper and other short-term loans as a result are likely to become more expensive, as loans are made at higher rates if there is a credible risk that the Fed will continue to hike its overnight rate. That will raise the cost of meeting payrolls and other day-to-day expenses.
The increased cost of expansion
The cost of financing business expansion moves up and down and in sync with the yield on 5-year Treasury notes. Corporations pay a risk premium that corresponds to the probability of default.
For instance, in 2025 as it became clear that indiscriminate tariffs would be applied, the risk premium for corporate loans increased compared with 5-year yields that were sinking.
The corporate market was caught responding to the uncertainty around the impact of tariffs on businesses, and the Treasury market was responding to the prospects of rate cuts if the economy were to grind to a halt.
That all changed when the U.S. attacked Iran, creating an energy shock and the inflation that followed and pushing interest rates in all markets higher.
The setting of 5-year Treasury yields
The impact of changes in the overnight federal funds rate has a direct impact on short-term money market rates, and a lessening impact on bond yields as you move out the maturity spectrum to 10-year and 30-year bonds.
For 5-year Treasury bonds, however, expectations of the short-term policy rate still play the major part in the setting of its yield as well as in corporate borrowing and lending, which is typically in the range of 5-year maturity.
There also is a term premium assigned to the 5-year Treasury note. This risk premium is estimated at nearly 0.50 percentage points as modeled by Adrian, Crunch and Moench at the Federal Reserve.
That 0.50 percentage point term premium is added to the 4.50 percentage points assigned to the role of market expectations of the policy rate, the sum of which determines the current 5% estimate of the 5-year yields.
The takeaway
Between the higher cost of short-term credit now that the Fed is raising rates, the cost of expanding that business is just as likely to rise with each hike in the overnight federal funds rate.
Pay close attention to the yield on 5-year Treasury bonds.
We will be publishing further work on the cost of capital and doing business. This is critical to the health and well being of the American middle market and economy.
