Article by Xu Chao, Wall Street Journal
The U.S. Treasury market is transmitting increasingly strong pressure signals to other asset classes, with equities being the first to feel the impact.
Long-term U.S. Treasury yields surged last week, with the 30-year yield reaching its highest level since 2007 and the 10-year yield breaking above the trading range it had maintained since late 2023.
Meanwhile, the ICE Bank of America MOVE Index, which measures expected volatility in the U.S. Treasury market, rose to its highest level since May, as demand for put options betting on falling bond prices surged. Data from the Chicago Board Options Exchange shows that the one-month put skew for the iShares 20+ Year U.S. Treasury Bond ETF climbed to its highest level since the 2008 financial crisis.
Over the coming week, details of the U.S. Treasury’s financing plan and the July non-farm payrolls report will be released, potentially further intensifying volatility in the bond market.
Bob Elliott of Unlimited Funds recently commented: “It’s difficult to judge how much longer other asset markets, such as stocks, can sustain themselves at current interest rates without being dragged down.” Gennadiy Goldberg, Head of U.S. Interest Rate Strategy at TD Securities, also warned that market conditions are precarious due to uncertainty surrounding Fed policy guidance, compounded by multiple sources of noise such as geopolitical factors.
The Fed's credibility is under scrutiny, causing long-term bond yields to break higher.
The primary driver behind this rise in U.S. Treasury yields is market skepticism regarding the Federal Reserve's policy credibility.
Since Kevin Warsh took charge of the Federal Reserve, he has taken a firm stance on combating inflation, yet inflation has remained above the Fed’s 2% policy target for five consecutive years, causing investors to question whether the Fed truly has the willingness to raise rates again.
Last Wednesday, the Federal Reserve’s interest rate decision-making committee saw a rare split—three regional Fed presidents voted in favor of a rate hike, opposing the majority of the committee. When Walsh concluded last week’s press conference, long-term bond yields surged while short-term yields declined simultaneously, causing the spread between them to narrow sharply. Analysis from Dow Jones Market Data showed this was the largest “Fed meeting day” yield curve compression since 2023.
Goldberg of TD Securities said: "The market is questioning how committed the Fed truly is to controlling inflation." He also noted that, under the base case, no rate hikes are expected this year or next, but the probability of hikes has "significantly increased."
Bond market volatility rises, driving a sharp increase in hedging demand
Yield fluctuations rapidly transmitted to the derivatives market, significantly increasing hedging demand.
The ICE Bank of America MOVE Index reached its highest level since May, indicating that traders are actively hedging against the risk of further interest rate increases.
Meanwhile, the trading volume ratio of put options to call options linked to the iShares 20+ Year U.S. Treasury Bond ETF (TLT) has risen significantly, with CBOE analysts noting that the one-month TLT put skew has surged to its highest level since the 2008 financial crisis.
Particularly noteworthy is that this round of long-term yield increases has diverged from oil prices—oil prices have declined rather than risen in tandem with yields, further weakening the correlation between yields and oil prices and heightening market uncertainty.
Spillover effects are emerging, raising the risk of pressure on stock markets.
Historically, turmoil in the U.S. Treasury market has been a precursor to equity market risk, and the current situation is causing significant unease among equity investors.
Bob Elliott noted in his commentary that whenever U.S. Treasury yields reach or approach current levels, pressure often begins to spread to other markets, with equities being the first to feel the impact. The current 30-year Treasury yield has reached 5.239%, and the 10-year yield stands at 4.693%, both within historical high ranges.
Goldberg also acknowledged that geopolitical uncertainty stemming from the situation in Iran, ambiguous guidance from the Federal Reserve, and a confluence of other market noise have together created today’s fragile market environment. “Various uncertainties are intertwining,” he said.
Multiple events are approaching; a crucial week of testing lies ahead.
The coming week will be a critical window to determine whether this round of U.S. Treasury pressure will spread.
Later this week, the U.S. Treasury will release details of its latest government financing plan, and any surprises could trigger renewed volatility in the bond market. Several key economic data releases are also scheduled for this week, culminating in the July nonfarm payrolls report on Friday, which will significantly influence market expectations regarding the Fed’s policy direction.
Meanwhile, last week, the U.S. Treasury, in coordination with the Federal Reserve and Japanese authorities, conducted a historic coordinated intervention to stabilize the continuously declining yen. Analysts believe that the U.S. participation in the intervention was partly motivated by a desire to prevent renewed volatility in the U.S. Treasury market.
The U.S. Treasury market, with a size of $30 trillion, is the cornerstone of the global financial system, serving as the primary collateral for short-term institutional liquidity and the benchmark pricing anchor for trillions of dollars in global debt. Should this "sleeping giant" remain persistently unsettled, its ripples will extend far beyond the bond market itself.