Original Author: Zhao Ying

Original Source: Wall Street Watch

The U.S. Treasury market is facing the most severe stress test in nearly twenty years. The sustained escalation of the situation in the Middle East, oil prices breaking the $100 mark, and a resurgence of inflation expectations have all combined to push U.S. Treasury yields higher across the board to multi-year highs. The 30-year Treasury yield has set a record for the longest consecutive high since 2007, causing a sharp shift in market judgments regarding the Federal Reserve's policy path.

On Thursday, the 10-year U.S. Treasury yield rose 4 basis points to 4.71%, reaching its highest level since January 2025. The 30-year yield rose to 5.19%, exceeding 5% for a longer period than any time since 2007. Meanwhile, Brent crude oil futures surged 7% in a single day, breaking the $100 per barrel mark, as markets focused on the escalation of conflict in the Middle East and reports of attacks on tankers near the Saudi coast.

The rapid rise in yields is quickly translating into higher financing costs for U.S. entities. The 10-year U.S. Treasury is an important pricing benchmark for housing mortgages and corporate loans. The average interest rate for 30-year fixed-rate mortgages in the U.S. has surged to 6.58% this week, the highest in nearly a year. U.S. stocks are also under pressure, with the Dow Jones Industrial Average falling nearly 1% on Thursday, the S&P 500 down 1.2%, and the Nasdaq Composite down 2.15%.

Goldman Sachs' trading desk previously identified the 10-year Treasury yield at 4.7%, WTI oil at $90, the VIX index at 20 points, and the S&P 500's 50-day moving average as key psychological thresholds. Currently, the 10-year yield has reached 4.7%. Nomura Securities analyst Charlie McElligott believes that the interest rate market is trying to preemptively trade other investors’ expectations of policy and is expressing discontent at the “hawkish hold” not being sufficient.

30-Year Yield Stabilizes Above 5%, Setting Record for Longest Duration Since 2007

The core of the current fluctuations in the Treasury market is the strengthening stickiness of long-term yields above 5%.

According to Dow Jones market data, the 30-year U.S. Treasury yield had remained above 5% for 11 consecutive trading days prior to Tuesday, setting a new record for the longest duration above 5% since 2007 on Wednesday. On Thursday, the 30-year yield continued to rise to 5.19%.

This level in itself does not automatically trigger a market crisis “red line.” Market participants generally believe that 5% is more of a notable round number that draws attention and is unlikely to force the U.S. to cease public market financing immediately. Bond prices move inversely to yield. Persistently rising yields indicate that investors are demanding higher returns to compensate for risks such as the erosion of returns by inflation, expanding fiscal financing, and increased long-term bond supply.

Dustin Reid, Chief Fixed Income Strategist at Mackenzie Investments, pointed out that for long-duration bonds, "the biggest enemy" is inflation. "If inflation remains high for a long time, investors will need to receive corresponding compensation."

Notably, unlike earlier in 2023 and earlier this year, this time, once the 30-year yield reaches 5%, it is difficult to quickly retreat. Alexander Payne, head of Mortgages, Institutional Debt, and Volatility business at Vanguard, stated that this round of selling does not have a single “trigger,” but there are no signs of a rapid “buying on dips” either. He believes that given the U.S. massive fiscal deficit and historical spending expectations for AI infrastructure, "there will be many opportunities to buy long-duration debt at higher yields."

Oil Price Shock Reignites Inflation Expectations, Interest Rate Bets Heat Up

Brent oil breaking above $100 per barrel is the direct trigger for this round of turmoil in the debt market.

The conflict between the U.S. and Iran, which began in late February of this year, has put continued pressure on energy markets. Previously, in June, as a ceasefire agreement between the U.S. and Iran was reached, oil prices had temporarily retreated, and inflation data also cooled. However, the fragile peace in the Middle East quickly collapsed, and Brent crude has rebounded significantly from its lows. Hamad Hussain, a climate and commodities economist at Capital Economics, stated, "Unless there are clear signs of de-escalation of conflicts around the world, the risks of oil prices rising remain considerable."

Before the surge in oil prices, institutions like Goldman Sachs and UBS had anticipated that the Federal Reserve would keep interest rates unchanged this year. However, the market has started to reprice for a more hawkish policy path. According to CME FedWatch data, traders are betting that the probability of the Fed raising rates at the next policy meeting has risen to 36%. Polymarket data shows that the market's bets on a rate hike by 2026 have increased to 71%.

Charlie McElligott, an equity derivatives analyst at Nomura Securities, warned in a report on Thursday that the interest rate market is essentially attempting to “anticipate the anticipators” and may be experiencing a “mini market tantrum,” indicating that “the hawkish hold is no longer sufficient.” He further pointed out that the oil shock suggests higher interest rate volatility, which will force central banks to reprice their hawkish stance, ultimately leading to a comprehensive tightening of cross-asset volatility.

Goldman Sachs' trading desk also advised the market to focus on several key psychological thresholds: the S&P 500's 50-day moving average (7462 points), the 10-year yield at 4.7% (last touched in January 2025), WTI oil at $90, and the VIX volatility index at the 20-point level. McElligott also warned that the VIX seasonality is set to “take off” in August, characterized by low liquidity and low risk tolerance.

Fiscal Financing and AI Bond Supply Increasing Pressure on Long-Duration Bonds

Oil prices are not the only reason for the rise in U.S. Treasury yields. Fiscal deficits, government bond supply and demand, and increased corporate long-term debt issuance are all changing the supply-demand balance for long-duration bonds.

The ongoing deterioration of the U.S. fiscal situation adds another layer of concern to the bond market. Defense Secretary Pete Hegseth estimated during testimony before Congress on Tuesday that the U.S.-Iran war has cost $37.5 billion to date, and the Trump administration is requesting an additional $67 billion in supplemental funding to support the escalating conflict. Meanwhile, the scale of U.S. national debt has reached $39.6 trillion, nearly five times the $8.35 trillion in August 2007, with the national debt as a percentage of GDP surpassing 100% this spring.

At the same time, the involvement of overseas buyers in the U.S. Treasury market has decreased compared to previous decades. Brij Khurana, fixed income portfolio manager at Wellington Management, noted that the presence of foreign buyers in the U.S. Treasury market has been steadily declining over the past few decades, despite the U.S. debt approaching $40 trillion and the issuance demand climbing. He believes that a “relay” needs to occur from foreign buyers to domestic holders, but domestic investors “may only be willing to take on” in times of stock market declines.

The bond market is also facing structural supply pressure from the corporate side. According to MarketWatch, citing BondCliQ data, the combined face value of unsold bonds from six tech giants, including Microsoft, Amazon, Alphabet (the parent company of Google), Nvidia, Meta, and Oracle, is approaching $500 billion by 2026, as the AI capital expenditure arms race provides bond investors with many alternatives to 30-year Treasuries, further diverting demand away from U.S. Treasuries.

Additionally, bond market trends are complicated by market speculations regarding the policy orientation of the new Federal Reserve Chair, Walsh. Walsh has committed to promoting central bank reforms and establishing a special working group to review communication mechanisms, inflation frameworks, and balance sheet policies. Tom Tzitzouris, Head of Fixed Income Research at Baird Strategas, stated, “The biggest driver at the moment may be Walsh’s narrative and how he will fulfill his duties as Chair of the Fed.”

Rising Interest Rates Begin to Test Stock Market Valuations and Housing Financing

The rising U.S. Treasury yields are now spreading from the bond market to U.S. stock and real estate markets.

In recent weeks, the U.S. stock market has responded relatively cautiously to the rise in oil prices. Piper Sandler's Chief Investment Strategist Michael Kantrowitz believes the stock market can maintain resilience around a 10-year Treasury yield of about 4.65% and an oil price of about $87, in part because short-term volatility remains low and corporate earnings expectations continue to be adjusted upward.

However, as oil prices rise to $100 and the 10-year yield breaks above 4.7%, this balance is beginning to come under pressure. Rising yields will increase corporate financing costs and compress the valuation space for overvalued assets. Tech stocks weakened on Thursday, leading to a widening drop in the Nasdaq Composite, indicating that the market's sensitivity to rising interest rates and capital expenditures is increasing.

The housing market is also facing direct impacts. The average interest rate for 30-year fixed-rate mortgages in the U.S. has risen to 6.58%, nearing a one-year high. Higher mortgage rates typically weaken refinancing activity and increase the monthly repayment burden for home buyers.

Reid of Mackenzie Investments warned that if the 30-year yield reaches 5.25%, the Treasury will begin to feel uneasy. “They don’t want the long end of the yield curve to spiral out of control, as that will undoubtedly pose risks to the stock market and valuations.” JPMorgan CEO Jamie Dimon also recently stated publicly that he would not buy long-term U.S. Treasuries at current prices and warned that the deficit issue “will become a problem,” when “bond vigilantes” will re-emerge.

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