Can US Treasuries 'Go Back'? 10-Year Yield Soars to Post-Financial Crisis High, Experts Warn 5% Is No Longer Ceiling

U.S. long-term Treasury yields continue to face upward pressure. On Wednesday, the U.S. Treasury auctioned $42 billion in 10-year notes, with the high yield reaching 4.683%, the highest level since 2007. This indicates that investors are demanding higher returns to absorb the massive government financing needs amid expanding federal deficits and inflation still above the Federal Reserve's target.

However, demand did not appear clearly out of control during this auction. The 10-year note's high yield was only slightly above pre-auction market levels, suggesting that while investors are seeking higher yields, overall demand broadly met market expectations.

The U.S. Treasury will auction 30-year bonds on Thursday, with market expectations pointing to a high yield potentially reaching the highest level in approximately 25 years. In addition to the U.S. government's massive borrowing, long-term Treasuries are simultaneously under pressure from inflation, economic growth, energy prices, and global bond market repricing.

Gregory Faranello, Head of U.S. Rates Trading and Strategy at AmeriVet Securities, stated that Treasury yields are unlikely to decline amid large fiscal deficits, resilient economic growth, ongoing conflicts, and inflation above the Fed's target.

Oil prices, corporate debt, and Japanese bonds are diverting demand away from U.S. Treasuries.

Recent challenges facing U.S. long-term bonds go beyond just the government needing to borrow more. Rising oil prices driven by Middle East tensions could make disinflation more difficult if energy prices continue to climb, thereby limiting the downside potential for long-term bond yields. Meanwhile, resilient U.S. economic performance is weakening investor appetite for Treasuries as a traditional safe-haven asset.

Corporate bond markets are also creating competition. As companies issue large volumes of debt to raise capital, U.S. Treasuries must offer more attractive yields to remain competitive in investors’ asset allocation.

With markets anticipating gradual monetary policy normalization by the Bank of Japan, rising Japanese government bond yields are increasing the domestic appeal of Japanese bonds, potentially diverting overseas capital—once a major source of demand for U.S. Treasuries—back to Japan.

The 10-year U.S. Treasury yield may no longer see 5% as a 'ceiling'.

These shifts are already reflected in investor performance. The Bloomberg U.S. Treasury Index fell 1.1% at the end of July, marking its largest monthly drop since March, before showing a slight rebound in August.

Some market participants believe there is further room for U.S. long-term yields to rise.

Mark Cudmore, strategist at Bloomberg, pointed out that strong U.S. economic growth, substantial government spending, and the AI investment boom could push Treasury yields even higher. He suggested that the 10-year yield of 5% could shift from being viewed as a 'ceiling' to becoming a 'floor' in the coming year.

Inflation data isn’t spiraling—but not low enough for the Fed to relax

Short-term Treasury yields remain influenced by expectations around Fed policy. The U.S. Consumer Price Index (CPI) released on Wednesday showed core CPI (excluding food and energy) rose 0.2% month-over-month and 2.5% year-over-year—the same annual increase as the lowest level since March 2021.

The inflation data came in below or in line with expectations, causing traders to reduce bets on a September rate hike by the Fed. Interest rate swap markets now price in about a 40% chance of a September hike, down from roughly 50% before the CPI release. However, markets fully reflect the possibility of one rate hike by year-end, indicating investors remain cautious about persistent inflationary pressures.

Steve Ryder, Senior Fixed Income Portfolio Manager at Aviva Investors, said the data is sufficient to keep a September hike possible but doesn’t provide the Fed with an urgent reason to act immediately. The Fed may focus more on the next CPI and employment reports before deciding whether further tightening is needed later this year.

Before the Fed’s September decision, two data points and the Global Central Bank Symposium will be critical

Since the Fed’s next rate meeting isn’t until September, market attention will now turn to August’s inflation and employment data.

Christopher Hodge, Chief U.S. Economist at Natixis North America, believes unexpected rate hikes must remain a possibility in the next few Fed meetings, but he still expects the Fed will ultimately ‘just barely avoid’ hiking. His reasoning includes inflation gradually moving toward target, cooling consumer spending, and a weakening labor market outlook.

Additionally, the Global Central Bank Symposium at Jackson Hole, Wyoming, at the end of this month will be a crucial event for observing policy signals from the Fed. Since taking office earlier this year, Fed Chair Kevin Warsh has deliberately avoided giving clear guidance on future rate paths. However, Faranello believes Jackson Hole could become an important occasion for Warsh to ‘fine-tune the inflation message’.

Even as long-term yields remain elevated, some investors are beginning to see value in certain long-dated bonds.

Brad Conger, Chief Investment Officer at Hirtle & Co., said his firm increased exposure after the 20-year Treasury yield surpassed 5%, based on a judgment that multiple forces are currently suppressing inflation—one of the most important being flat real wages.

Thus, the current U.S. Treasury market features two opposing forces. In the short term, inflation and fiscal deficits make it difficult for long-term yields to fall. But if employment and consumption continue to cool, the Fed may ultimately refrain from further hikes, potentially creating room for long-term bonds to rebound.

The upcoming 30-year Treasury auction will be a key indicator of how high a yield the market is willing to accept to finance U.S. fiscal needs. If long-term yields continue setting new highs, the question will no longer be simply ‘Are U.S. Treasuries worth buying?’ but rather how high a financing cost the U.S. government must pay to sustain its massive fiscal deficit.