The US 10-year Treasury yield breached the 5% threshold on Monday, reaching its highest level since October 2023, as investors braced for the Federal Reserve's policy decision later this week. The benchmark yield peaked at 5.014% before easing to 4.99%, while the 2-year yield added more than 2 basis points to 4.666%. The 30-year yield also climbed 2 basis points to 5.374%.
With the Fed's two-day meeting set to begin Tuesday, market pricing has shifted decisively toward a 25-basis-point rate hike. According to the CME Group FedWatch tool, the probability of such a move stands at 90%, while Prime Terminal shows odds at 93%. This marks a significant repricing from just a few weeks ago, when markets were split between a hold and a hike.
Yields climb as inflation data lands
The latest leg higher in yields follows Friday's release of the August consumer price index, which matched expectations but remained well above the Fed's 2% target. That report was the final major inflation indicator available to policymakers before their September meeting, making it a key input for their decision.
The 2-year Treasury yield, which is particularly sensitive to Fed policy expectations, reached its highest level since July 2024 last week. Investors will now scrutinize the central bank's updated economic projections and the so-called dot plot for clues about the future path of interest rates.
Jay Woods, chief market strategist at Freedom Capital Markets, said a rate hike would be "the cleaner decision" given the economic data and current market expectations. He noted that markets have already priced in a hike, so a move could trigger a relief rally. Conversely, he warned that leaving rates unchanged might spark a negative reaction, as it could signal the Fed is falling behind the curve.
Why the 5% level matters
The 10-year yield's push to 5% is a psychologically important milestone. A move above 5.02% would take it to its highest level since July 2007, before the Global Financial Crisis. The drivers behind this rise are crucial for financial markets: higher yields stemming from strong economic growth can have different implications for stocks and the broader economy than increases caused by inflation, fiscal deficits, or Treasury market stress.
However, the 5% level could become more challenging for equities if investors demand greater compensation for inflation and fiscal risks. Large federal deficits, heavy debt issuance, and persistent inflation have contributed to a rising term premium—the extra yield investors require for holding longer-term bonds.
Oil adds to inflation worries
Rising crude oil prices have introduced another potential source of inflation pressure as the US-Iran conflict escalates. Recent energy price gains, along with a Houthi attack on the Saudi Arabia East-West pipeline, have pushed oil higher amid concerns about supply disruptions. This adds to the inflationary backdrop that the Fed must navigate.
Treasury Secretary Scott Bessent has sought to ease pressure at the longer end of the yield curve through an expanded bond buyback programme. However, BMO Capital Markets strategists argue that a more active programme could limit selling pressure but would not address the fundamental forces pushing 10- and 30-year yields higher. Investors are also monitoring risks from leveraged hedge-fund positions in the Treasury market.
For now, investors have tolerated higher yields. BMO noted that when the 10-year yield reached 4.85%, equity weakness remained modest, and the S&P 500 was still up more than 11% for the year. The rise in Treasury yields has also supported the US dollar, with the Dollar Index up nearly 0.60% at 99.66 after rebounding from 99.07.
As the Fed decision approaches, market participants are weighing the implications of a potential hike against the backdrop of gold sliding amid oil and yield pressures. Meanwhile, equity markets have shown resilience despite the yield surge, though the sustainability of that resilience remains uncertain.
This article is for informational purposes only and does not constitute financial advice.
