A Federal Reserve that has zipped its lip on the path for its future interest-rate moves, an unexpectedly resilient U.S. economy, and renewed hostilities with Iran have together driven a selloff in the world’s largest government bond market.
In turn, bond prices have slumped, impacting consumers and increasing pressure on Fed chairman Kevin Warsh, who will lead the central bank’s policy meeting next week.
Yields and bond prices move in inverse directions—and rising yields ding the value of older, lower-yielding bonds. The yield on the 10-year U.S. Treasury note settled at 4.678% on Friday, while the yield on the 2-year note settled at 4.328%, near their highest levels since early 2025. The 30-year yield has now closed solidly above 5% for several days.
Mortgage rates are largely determined by the 10-year Treasury yield—and prospective home buyers may now be thinking twice. A 30-year fixed-rate mortgage averaged 6.58% this week, Freddie Mac said Thursday. That is compared with 6.43% at the start of July and around 6% at the start of the year.
Higher yields can also drive up credit-card rates and increase borrowing costs on newly issued corporate and government debt. Illustrating this upward shift on Thursday was the Treasury department’s auction of 10-year Treasury inflation-protected securities, which offer inflation-adjusted returns that are also called real rates. Before the auction, the real rate for the 10-year Treasury was at its highest level since late 2023.
The 10-year Treasury yield, which reflects its real rate, plus extra compensation demanded for future inflation, has risen by about 0.76 percentage points from its lows in February.
“All but one basis point of the yield rise has been driven by real rates. Thus, those arguing that bond yields have shot up due to inflationary fears have the story backwards,” wrote Michael Darda, a market strategist at ROTH on Friday.
Higher real rates aren’t causing the problem, but are rather a symptom that stems from Warsh’s approach to monetary policy, which has so far involved offering less market clarity than his predecessor Jerome Powell did. The strategy “involves more volatility around Fed events,” wrote BMO Capital Markets’ Ian Lyngen in a note on Friday.
“Over time, this volatility could translate into greater term premium and put upward pressure on real yields which is already becoming evident,” he added.
Real yields have also increased as investors demand a higher premium to steer away from risk assets amid a time of strength for the U.S. economy. Consumer spending, which makes up nearly 70% of U.S. gross domestic product, remains stable, as do retail sales.
Concerns stoked by the U.S. and Iran resuming hostilities have also weighed on yields, while the price of West Texas Intermediate crude oil has been directionally consistent for the last five consecutive trading days. But the oil-yield correlation has weakened since early May—meaning any pause in fighting can’t be trusted to bring down Treasury yields much in the future.
Investors’ worries about government debt, plus their increased expectations that the Fed will hike rates this year, are also affecting bond prices and raising yields.
The bond market can prove to be difficult for the Fed. Market expectations for average annual inflation over the next 10 years, or 10-year breakevens, have remained well-anchored, ranging between 2% and 2.5% since 2023. That is despite near triple-digit crude prices recently, which suggests the bond market thinks that the Fed will be able to contain inflation over the long term.
Lyngen wrote that if the central bank’s policymaking arm, the Federal Open Market Committee, decides to unexpectedly hike rates during its July meeting, the move may be initially bad for bonds, but “we’d expect such a move to ultimately be constructive for duration,” or lower long-term yields. A hike “would serve to reinforce Fed credibility and further compress breakevens,” he added.
Conversely, if the FOMC appears hesitant to fight inflation at future policy meetings, these breakevens could climb and push Treasury yields higher.
Write to Karishma Vanjani at karishma.vanjani@dowjones.com.
