U.S. Treasury Market Trapped in Triple Storm of Inflation, Tightening, and Supply as Yields Surpass 4.8%

[Mexico City = Shim Young-jae, Correspondent] The U.S. Treasury market has once again come under pressure from inflation and fiscal burdens. With international oil prices soaring to around $95 per barrel, concerns over rising prices have intensified, compounded by the U.S. fiscal deficit and the burden of large-scale Treasury supply, leading to continued selling pressure on long-term bonds. Additionally, the possibility of further interest rate hikes by the Federal Reserve (Fed) has emerged, pushing the yield on 10-year Treasury bonds to surpass 4.8%, marking the highest level since November 2023.

On the 2nd (local time), the yield on 10-year Treasury bonds rose to 4.814% during trading. Some market estimates indicated that the peak exceeded 4.818%. Subsequently, buying pressure emerged, causing the yield to retract to around 4.77% to 4.80%, but the focus of the bond market is on how close the 10-year yield can get to the psychological resistance level of 5%. The yield on 30-year Treasury bonds also rose to around 5.3% before retreating to the 5.25% to 5.26% range. In contrast, the yield on 2-year bonds, which are relatively sensitive to the Fed's monetary policy outlook, remained around 4.4%.

Surge in Oil Prices Awakens Inflation... 10-Year Yield Breaks 4.8%

The direct catalyst for the rise in Treasury yields was energy prices. Renewed military tensions between the U.S. and Iran have heightened concerns over oil supply disruptions, with Brent crude surpassing $95 per barrel during trading. In some trades, it soared to $97. West Texas Intermediate (WTI) also exceeded $90.

The rise in oil prices carries implications for the bond market beyond simple geopolitical risks. If rising energy prices push consumer prices and corporate costs higher, the Fed may be compelled to maintain high policy rates for a longer period or consider further hikes. Typically, when geopolitical conflicts escalate, funds move into safe-haven U.S. Treasuries, causing yields to fall; however, this time, the inflation shock from rising oil prices seems to be overwhelming the preference for safe assets.

Another characteristic of this movement is that long-term yields are rising simultaneously not only in the U.S. but also in major countries. The yield on Japan's 10-year Treasury bonds has reached its highest level in about 30 years, and yields in major European countries such as the UK, Germany, and France are also under upward pressure. This suggests a long-term bond sell-off that reflects inflation, fiscal health, and the global expansion of bond supply, rather than a mere reassessment of a single country's monetary policy.

Kiran Ganesh, a multi-asset strategist at UBS Global Wealth Management, analyzed that the recent rise in energy prices has added upward pressure to bond yields that were already rising due to fiscal concerns. David Morrison, chief market analyst at Trade Nation, also explained that investors are closely monitoring government debts and the continuously expanding fiscal deficits in various countries.

Ultimately, what the market demands is a higher 'compensation.' From the perspective of investors lending funds for a long period, the higher inflation rises in the future, the more real yields are eroded. If the increase in government debt leads to an expansion in Treasury supply, investors will demand higher yields as compensation for holding long-term bonds. This is why long-term yields are experiencing stronger upward pressure than short-term yields in the current market, where both oil prices and fiscal deficits are prominent.

Possibility of Further Fed Hikes... Fiscal and AI Bond Supply Also Burdening

The outlook for monetary policy is also adding pressure to the Treasury market. Kevin Warsh, the Fed Chair, recently signaled a hawkish stance, indicating that he may raise policy rates further to curb inflation. Following this, Fed Governor Michael Barr stated that if inflationary pressures do not sufficiently ease, a rate hike in September may be necessary. Consequently, prediction markets like Polymarket have reported that the likelihood of a September rate hike has risen to 56% following Warsh's comments.

What the bond market is particularly wary of is not just the short-term shock from oil prices. Concerns are also growing that the expansion of the U.S. fiscal deficit and increased Treasury supply could raise the lower bound of interest rates in the long term. With U.S. federal debt surpassing $40 trillion, the simultaneous increase in government funding needs and corporate bond issuance is intensifying competition for bond investment funds.

The emergence of AI infrastructure investment as a new variable is also noteworthy. Major tech companies such as Alphabet, Amazon, Meta, Microsoft, and Oracle are issuing large-scale bonds this year for AI infrastructure development. According to related analyses, the total bond issuance by these companies this year is expected to reach $220 billion. As it becomes increasingly difficult to cover AI investment costs solely with excess cash flow, funding through the corporate bond market is on the rise.

When both the government and large tech companies supply large volumes to the bond market, they must offer higher yields to secure limited investment funds. This creates a structure where inflation concerns pressure long-term bond prices on the demand side, while the expansion of Treasury and corporate bond supply stimulates interest rate increases on the supply side.

"4.8% is also low" Claims... Market Watches 5% Level

Regarding these structural issues, Peter Schiff, chief economist at Euro Pacific Asset Management, argued on X (formerly Twitter) that the recent rise in Treasury yields should be linked to expectations of inflation, weakening trust in U.S. fiscal policy, and issues of the Fed's credibility and independence, as well as de-dollarization movements.

Schiff compared historical interest rates with the current level of U.S. debt, stating that a 10-year yield of 4.8% is not absolutely high. He noted that the average yield on U.S. 10-year Treasury bonds in the 1980s was 10.6%, and in the 1990s it was 6.7%. He also mentioned that the average yield in the 1970s was around 7.5%, arguing that given the current scale and growth rate of U.S. debt, it is unlikely that yields will remain consistently low at the 4.8% level.

In fact, the more critical point in the market is that the 10-year yield is approaching 5%. The 10-year yield broadly influences mortgage rates, auto loan rates, corporate funding costs, and stock valuations. As it gets closer to the 5% level, the expected returns demanded by risk asset investors also increase, which could put pressure on growth stocks that are subject to high valuations. Reuters also assessed that the 10-year yield, which reached 4.8%, is rapidly approaching the important 5% level for mixed-asset portfolio investors.

However, during the day's trading, there were signs that the one-sided rise in yields was somewhat calming. The 10-year yield rose to 4.8172% before retreating to around 4.78%, showing the possibility of breaking a five-day streak of increases. The 30-year yield also rose to 5.3028% before retreating to the 5.25% range. As the upward trend in long-term yields eased, U.S. stocks also alleviated some of the early session pressure.

In the morning session, U.S. stocks turned upward. The Dow Jones Industrial Average rose by about 0.5%, while the S&P 500 and Nasdaq indices increased by approximately 0.6% and 0.5%, respectively. The volatility index (VIX) fell by more than 5%. This is interpreted as a result of bond yields retreating from their intraday highs, alleviating some concerns about deteriorating financial conditions.

Employment data also somewhat limited the rise in yields. According to ADP, U.S. private employment increased by 38,000 in August, falling short of the market expectation of 47,000 and marking the lowest increase since January. As inflation risks grow, the labor market is sending signals of slowdown, complicating the policy decisions facing the Fed.

The key point in the U.S. Treasury market is not simply that the 10-year yield has surpassed 4.8%. In a situation where short-term inflation expectations are rising again due to rising oil prices, the possibility of further tightening by the Fed is highlighted, and the structural burdens of the U.S. fiscal deficit and expanded Treasury supply are also being reflected in prices. Additionally, the large-scale corporate bond issuance by companies due to increased AI investment is compounding the supply-demand pressures in the bond market.

The fact that the 10-year yield, which surpassed 4.8%, has retreated back to the 4.7% range indicates that the market is not yet betting on a one-sided move towards 5%. However, if international oil prices remain high and concerns about fiscal and bond supply are not alleviated, long-term yields may respond even more sensitively to upcoming inflation indicators and the Fed's September monetary policy decisions. The return of the 4.8% yield, which has not been seen since November 2023, shows that the U.S. bond market is entering a phase of evaluating not only 'inflation and monetary policy' but also 'fiscal and supply' simultaneously.

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