Original Title: Yields Surge to Multi-Decade Highs as Traders Price More Rate Hikes Ahead

Original Author: Riskreversal

Editor's Note: The Federal Reserve has just resumed rate hikes, and the U.S. bond market has already begun pricing in the next hike, or even the two after that.

On September 23, stronger-than-expected U.S. PMI data reinforced the judgment that inflationary pressures have yet to subside. The 10-year Treasury yield rose about 15 basis points in a single day, briefly climbing to 5.13%, the highest since 2007; meanwhile, market pricing for another 25 basis point hike in October quickly rose to about 70%, and expectations for further tightening in December also clearly heated up.

For some time, the rise in Treasury yields has largely moved in sync with rising oil prices: energy prices pushed up inflation expectations, and the market responded by betting on a more hawkish Fed. But this time, a more noteworthy shift is emerging—even if oil prices do not continue to hit new highs, as long as the U.S. economy remains strong, the market may still keep raising its pricing for further rate hikes.

This means the core variable affecting Treasuries and risk assets may be shifting from a pure "energy shock" to a more troublesome question: Was the September hike merely an adjustment, or the beginning of a new tightening cycle?

The following is a translation of the original article:

On September 23, the most dramatic move in U.S. markets was not in stocks, but in bonds.

The 10-year Treasury yield rose about 15 basis points that day to 5.11%, briefly reaching 5.13% intraday, the highest level since 2007. Yields on Treasuries from 2-year to 30-year maturities also broadly rose sharply.

U.S. stocks came under pressure as a result. The S&P 500 fell about 0.8%, the Nasdaq dropped nearly 1%, and small-cap stocks were hit even harder. But compared with the one-day decline in stocks, what deserves more attention is the reason driving this round of adjustment.

Strong PMI Pushes the Market to Bet on Consecutive Rate Hikes

The direct catalyst in the market that day was a PMI reading that was clearly stronger than expected.

U.S. business activity continued to expand in September, economic growth remained strong, and price pressures were still elevated. For a Federal Reserve that has just resumed rate hikes, this is not an easy combination to ignore.

If the economy cools rapidly, the market could interpret a September rate hike as a limited adjustment aimed at a rebound in inflation; but if growth remains strong and price pressures show no clear signs of easing, the Fed will have more room to continue tightening policy.

The market reacted quickly.

As of that day, traders' pricing for another 25 basis point rate hike in October had risen to about 70%; at the same time, the probability of a further rate hike in December also exceeded 50%.

This was also the core backdrop for the rapid rise in U.S. Treasury yields that day.

The subsequent 5-year U.S. Treasury auction saw weak demand, further amplifying selling pressure in the bond market. In other words, what the market is now discussing again is no longer "whether there will be a rate hike in September" — that question is already settled.

The new question is: how many more times does the Fed actually need to hike?

U.S. Treasuries are breaking away from their sole dependence on oil prices

Over the past few months, there has been a relatively clear trading chain between oil prices and U.S. Treasury yields.

Rising energy prices increase the market's concerns about a reacceleration of inflation; rising inflation expectations in turn force investors to reassess the Fed's policy path, thereby pushing medium- and long-term U.S. Treasury yields higher.

As a result, the market has frequently seen oil prices and 10-year U.S. Treasury yields rise in tandem recently.

On September 23, crude oil prices also rebounded, so the energy factor was still present. But this time, the rise in U.S. Treasury yields was significantly larger, and the more important change behind it was that the market suddenly increased its pricing for further rate hikes within the year.

This means a new trading framework may be taking shape: oil prices do not necessarily need to keep rising for U.S. Treasury yields to continue climbing. As long as economic data remain strong, inflation is not cooling fast enough, and Fed officials continue to send hawkish signals, the market may continue to bet on a higher policy rate.

This is also the most important change in the current rates market.

Previously, investors were more focused on whether energy prices would continue to create an inflation shock; now they have begun directly discussing whether the Fed needs to keep rates at a higher level, or even push them further upward.

If this pricing persists, then judging whether 10-year U.S. Treasury yields have peaked cannot rely only on crude oil.

The real risk is that high rates begin to affect credit

Interest rates rising above 5% does not necessarily mean the U.S. economy or stock market will immediately run into trouble. As long as the economy remains strong enough and both corporate earnings and household incomes can still absorb financing costs, high rates themselves can persist for quite a long time.

What truly needs to be watched is the next step: when high rates begin to affect credit.

Investor Danny Moses pointed out on a program that an interest rate level of around 5% to 6% is not entirely unbearable in itself; what is more worrying is that credit issuance begins to slow.

This distinction is very important.

Financial conditions truly transmit to the real economy not because the 10-year U.S. Treasury breaks through some round-number threshold, but because higher risk-free rates eventually feed into corporate loans, mortgages, auto loans, and other financing costs. Once banks and other financial institutions begin to shrink credit, corporate investment and household demand may truly come under pressure.

Therefore, the more important question going forward than "whether the 10-year U.S. Treasury has broken through 5%" is: will high rates begin to drag on credit creation.

The bond market is already volatile, but the stock market is still calm

Another signal worth watching comes from the volatility market.

The 10-year U.S. Treasury yield saw a sharp move of about 15 basis points in a single day, but the VIX rose only to about 15.2 that day, still at a relatively low level. At the same time, the implied expected move for the S&P 500 options for the next trading day was still only about 0.5%.

This creates a clear contrast: the bond market has already been sharply adjusting its judgment on the future path of interest rates, but the stock market still treats it as a relatively ordinary pullback.

Of course, this does not mean U.S. stocks will necessarily see an immediate sharp decline. If the economy continues to remain strong and corporate earnings can offset the interest rate pressure on valuations, then stocks may still withstand higher rates.

But the problem is that once U.S. Treasury yields continue to rise while economic data begin to weaken, the currently low implied volatility of stocks may face repricing. This is also the most noteworthy dislocation for the market in the coming days.

Next, it is not just about oil prices, but whether rate hike expectations can continue to heat up

Next, whether U.S. Treasuries can stabilize above 5% will become an important signal for judging whether this round of trading continues.

If the 10-year yield quickly falls back, then the volatility on September 23 may still be more of a short-term shock amplified by strong data, U.S. Treasury auctions, and positioning. But if oil prices do not continue to rise significantly while U.S. Treasury yields remain high or even rise further, then the logic the market is trading on will become clearer: the core force driving rates higher is no longer just an energy shock, but a repricing of further Federal Reserve tightening.

What needs attention next is not just CPI or crude oil, but employment, consumption, housing, and credit data.

If the economy continues to show strong performance and inflationary pressures remain sticky, the market may further increase its pricing for October and December rate hikes; conversely, if employment or the credit environment begins to deteriorate markedly, the currently rapidly heating rate hike expectations may also cool again.

Therefore, the 10-year U.S. Treasury yield breaking through 5% is only a surface phenomenon.

The real question that needs to be answered is: Is the September rate hike merely a one-off policy correction, or the beginning of a longer tightening cycle.

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