The risk premium investors demand for taking positions in equities and credit markets compared to a safe-haven asset like U.S. Treasuries has narrowed sharply, with 10-year Treasuries yielding 4.25% as of early July, raising their competitiveness with stocks and credit markets.

Equity and credit risk premiums typically measure their returns against 10-year Treasury notes, which have remained steady as the Federal Reserve (Fed) paused its monetary easing after cutting rates in December 2024 amid sticky inflation. Equities, on the other hand, have been surging since late 2022, narrowing the equity risk premium (ERP) with Treasuries. While there are various tenors of U.S. government fixed income securities that could be used as the risk-free rate, we focus solely on the 10-year Treasury note given its liquidity and common use as the singular risk-free rate. 

The size and direction of the risk premium signify secular shifts in capital markets returns and asset-allocation decisions. The S&P 500 ERP is at a five-year low, and Investment Grade and High Yield credit risk premiums are steadily declining from their highs in the summer of 2023. Market participants can use CME Group equity and credit futures to manage their exposure to changing risk premiums.

Since early 2024, as U.S. equity markets rallied to new highs and bond yields reached attractive levels, investors have been pondering whether the shrinking ERP should be a cause for concern. 

Equity risk premium varies through time depending on market conditions, even dipping into negative territory at times. Historically, negative equity risk premium has been accompanied by market corrections. 

The correction scenario appears to be playing out in the equity markets. Year-to-date, the major U.S. equity indices are barely positive. For the first time since August 2002, ERP turned negative in March 2024, signaling that equity valuations are stretched, and stocks may be overvalued. Furthermore, the negative ERP brings up the question of whether market participants should meaningfully shift away from their equity allocations and move into safe-haven assets.

Shrinking or negative S&P 500 ERP can have meaningful implications for near- to medium-term asset allocation, with investors recalibrating returns expectations, and positive returns from U.S. equities are facing headwinds. 

The shift is already underway in 2025 with both developed and emerging markets equities outperforming U.S. equities. With forecasts of five-year future returns from those markets being higher than those of U.S. equities, the implications are that the dominance of U.S. equity may be coming to a close. In that light, a degree of repositioning of portfolios away from U.S. stocks is taking place, with outflows from U.S. equity funds ($17 billion) and inflows into international equity funds ($7 billion) in May 2025.

*AQR 2025 Capital Markets Assumptions for Major Asset Classes.  Performance data as of June 30, 2025 based on total returns in USD.  U.S. Equity is represented by S&P 500, Developed ex. U.S. Equity is represented by MSCI EAFE and Emerging Markets Equity is represented by MSCI Emerging Markets Index.

It is still too early to tell whether this change in fund flows is transitory or long-lasting. History shows that the payoff from harvesting ERP is positive and stocks still earn excess returns over cash when held for a longer duration. Using the returns of the S&P U.S. Equity Risk Premium Index, it appears that going long E-mini S&P 500 Futures and shorting U.S. Treasury bonds futures could result in a positive premium over the long-term investment horizon.