[U.S.-driven High Interest Rates] 30-year Treasury Yield Touches 5.2% Annually... Fed Rate Hike Expectations Spread

[U.S.-driven High Interest Rates] 30-year Treasury Yield Touches 5.2% Annually... Fed Rate Hike Expectations Spread

War-driven high oil prices, concerns about re-ignited inflation... structural factors such as fiscal deficit

Stock market and economic anxiety... rising borrowing costs for government, corporations, and households

U.S. ultra-long-term Treasury yields have surged to their highest level in nearly 20 years, casting a shadow of anxiety over the U.S. stock market and economy.

The main reason for the sharp rise in U.S. Treasury yields, especially long-term bond yields, is the spreading expectation that the Federal Reserve (Fed), the U.S. central bank, will implement an interest rate hike within the year.

As the perception spreads that the interest rate cut trend, a key foundation that has supported the rise in the U.S. stock market and strong economic growth prospects, is coming to an end, the trend of U.S. Treasury yields has emerged as a matter of keen interest in global financial markets.

Rising interest rates are identified as a risk that could trigger an increase in borrowing costs and slow down U.S. economic growth.

◇ 30-year U.S. Treasury Yield Hits 5.2% Annually... First time since 2007

On the 19th (local time), the 30-year U.S. Treasury yield temporarily surged by 7 basis points (1bp = 0.01 percentage point) to 5.20%. It is the first time since July 2007, just before the global financial crisis, that the 30-year yield reached 5.20%.

The 10-year U.S. Treasury yield, a benchmark for global bonds, also temporarily rose by 10 basis points to 4.69%, setting a new high since January 2025. The 10-year yield appears to be continuing its upward trend after breaking through the 4.5% line, which is considered a strong psychological resistance level, on the 15th.

Subsequently, the sharp rise in long-term yields calmed down somewhat, ending the week's trading on the 22nd at 5.06% and 4.56%, respectively.

Will McGough, CIO of Prime Capital, commented, "'Bond Vigilantes' are on the move." Bond vigilantes refer to investors who sell government bonds in response to fiscal and monetary policies that could trigger inflation.

◇ War-driven high oil prices... "Inflation may not be temporary"

The biggest factor in the sharp rise in U.S. long-term Treasury yields is the high oil prices caused by the Iran war.

With the Strait of Hormuz, through which about 20% of the world's crude oil and petroleum products pass, blocked, Brent crude, the international oil price benchmark, surged to over $100 per barrel. A level 60% higher than before the outbreak of the war is being maintained.

In particular, as peace negotiations between the U.S. and Iran remain deadlocked, high oil prices are expected to persist, raising concerns that this will re-ignite inflation.

The U.S. Consumer Price Index (CPI) in April rose 3.8% year-on-year, marking the highest increase since May 2023. This is significantly higher than the 2.4% in February, just before the war's outbreak. Core CPI, excluding volatile energy and food, rose 2.8% year-on-year.

The core Personal Consumption Expenditures (PCE) price index, which the Fed uses as a benchmark for monetary policy, rose 3.2% year-on-year in March. While it had previously exceeded the Fed's target (2.0%), the disparity has widened further. A rise in the 3% range is expected to continue in April and May.

The Iran conflict is not the only factor driving interest rate increases.

Analysis suggests that the rise in long-term yields, in particular, has structural backgrounds such as inflation exceeding the Fed's target for several years and supply-demand conditions.

In September 2024, the Fed ended its monetary tightening stance after four and a half years by lowering the policy rate by 0.5 percentage points from 5.25-5.50%. Since then, it has been lowered to the current 3.5-3.75%.

During the same period, the 30-year U.S. Treasury yield moved in the range of 4.0-5.1%. Although the policy rate was cut by 1.75 percentage points, the 30-year yield did not reflect this trend of policy rate cuts.

This is because long-term inflation expectations have not fallen to 2%, and the U.S. federal government's fiscal deficit has worsened. While the federal government's issuance of Treasury bonds continues to increase, the 'safe-haven status' of U.S. Treasury bonds has been shaken.

◇ Fed's expectation of rate hike within the year grows

Accordingly, expectations that the Fed will further cut interest rates within the year have disappeared, and forecasts are spreading that the Fed will move beyond freezing rates to raising them.

According to FedWatch by the Chicago Mercantile Exchange (CME) on the 23rd, the interest rate futures market reflected a 42.5% probability that the Fed would raise rates by 25 basis points by December. A month ago, the probability was 'zero'. Conversely, the probability of a rate freeze decreased from 75.9% a month ago to 32.1%. The probability of a rate cut has disappeared.

The dominant view is that it will not be easy for Kevin Warsh, the incoming Fed Chair who took office on the 22nd, to deliver the interest rate cuts that President Donald Trump desires.

The Federal Open Market Committee (FOMC), which determines interest rates, has 12 voting members in total, including 7 Fed governors, including Chair Warsh, and 5 presidents of regional Federal Reserve Banks. The structure is not one where the Chair alone can determine interest rates.

The minutes of the FOMC meeting held on April 28-29 confirmed that a majority of members expressed a hawkish (preferring monetary tightening) stance, indicating that they might need to raise the policy rate if inflation continues to exceed the target level.

Even Fed Governor Christopher Waller, who had previously been classified as dovish (preferring monetary easing), recently stated in a public lecture that "if inflation does not calm down soon, the possibility of future rate hikes can no longer be ruled out."

Subadra Rajappa, Head of U.S. Research at Societe Generale Americas, told Bloomberg, "Nominee Warsh is joining the Fed at a time of rising inflation, and his dovish leanings will be challenged by both the market and his fellow Fed governors."

There are also observations that the Fed has become cautious in evaluating inflation due to high oil prices as "temporary." The Fed had judged inflation in 2021-2022 as a "temporary phenomenon" but later raised rates sharply, which drew much criticism. Chair Warsh was also one of those who criticized this as a "policy error."

◇ Rising borrowing costs are a risk to U.S. stock market and economic slowdown

Rising Treasury yields increase borrowing costs for the U.S. government, corporations, and households.

The ratio of publicly held national debt to U.S. GDP exceeded 100% at the end of the first quarter, reaching 100.2%. Excluding a temporary rise in the second quarter of 2020 during the COVID-19 pandemic, this is the first time this ratio has exceeded 100% since immediately after World War II.

The U.S. Congressional Budget Office (CBO) projects that the U.S. federal government's fiscal deficit as a percentage of GDP will be around 5.8% this year, similar to last year. This suggests that the widened fiscal deficit will not be reduced.

Rising Treasury yields increase the federal government's borrowing costs, further exacerbating the fiscal deficit. Last year, the federal government spent $970 billion on net interest costs alone.

It also pushes up mortgage rates. As of the 18th, the average interest rate for a 30-year fixed-rate mortgage in the U.S. was 6.49%, up 0.04 percentage points from a week ago. This is similar to the level in September last year, when the Fed began its three consecutive rate cuts.

Rising mortgage rates are a major factor undermining 'affordability,' which President Trump emphasized ahead of the November midterm elections.

Corporate earnings forecasts, which drive U.S. stock price increases, could also be shaken.

Despite global energy supply chain disruptions, S&P 500 earnings forecasts continue to be revised upward, but there are concerns that increased borrowing costs could slow or reverse this trend.

In particular, as big tech companies, which drive economic growth, actively utilize external borrowing such as bond issuance to continue large-scale capital expenditures (CAPEX) for AI infrastructure investment, rising interest rates could lead to increased funding costs and slow down investment.

Small and medium-sized enterprises, which have received concentrated loans from the private credit market where investor concerns have grown, are particularly vulnerable in a rising interest rate environment.

Along with this, the impact of high oil prices is already showing signs of slowing U.S. retail sales growth. Retail sales in April increased by 0.5% month-on-month, a significant slowdown compared to March (1.6%). Retail sales are an indicator that can gauge changes in consumption, the backbone of the U.S. economy.

There is also a forecast that rising energy prices and borrowing costs could ultimately lead to "demand destruction." This means that economic activity could slow down as consumers reduce spending and businesses cut back on investment.

However, in this scenario, the Fed would prioritize curbing economic slowdown over curbing inflation, providing conditions for a return to accommodative monetary policy.