Inflation, deficits, and AI-driven bond issuance are all putting pressure on the market, with over half of market participants betting that the 30-year US Treasury yield will reach 6% by the end of the year.

The yield on 10-year US Treasury bonds broke through the 5% mark, and the upward pressure on long-term interest rates has not subsided. Meanwhile, changes in the structure of US Treasury bond buyers are making the market more prone to sharp fluctuations.

Inflation remains above target, the US economy remains resilient, the Federal Reserve has resumed its interest rate hikes, and the continued expansion of US fiscal financing needs are all contributing to the rise in long-term US Treasury yields. Meanwhile, the number of price-insensitive foreign official investors is gradually decreasing, while more price-sensitive investors such as hedge funds are taking on more US Treasuries, meaning the market may be more sensitive to changes in capital flows.

On Wednesday, the yield on the 10-year U.S. Treasury note rose 14 basis points in a single day, briefly breaking through 5.1% and reaching a new high since 2007; the yield on the 5-year U.S. Treasury note also broke through 5%, reaching a similar high since 2007. The yield on the 10-year Japanese government bond rose to its highest level since 1996 on Thursday, putting pressure on global bond markets.

Inflation has not subsided, but the economy remains resilient.

The current rise in yields is primarily supported by fundamentals. The US PCE price index rose 3.7% year-on-year in July, still significantly above the Federal Reserve's 2% target. Rising oil prices have increased the uncertainty surrounding a decline in inflation; if energy prices remain high, it could further prolong the time needed for inflation to cool down.

At the same time, the US economy has not shown any significant slowdown. The job market remains stable, consumption continues to be supported, and the investment boom driven by the construction of AI data centers is also boosting corporate capital expenditure.

The resilience of the economy gives the Federal Reserve no urgent reason to quickly shift to an easing stance. The Fed recently raised its policy rate by 25 basis points to 3.75% to 4%. Fed Governor Michael Barr stated that further policy adjustments may still be necessary given that inflation remains above target and economic growth is strong; Chicago Fed President Austan Goolsbee said that the process of inflation returning to 2% will not be smooth sailing.

Therefore, long-term yields face triple pressures from inflation, growth, and monetary policy, rather than just short-term oil price shocks.

US Treasury buyers are becoming "vulnerable," increasing the risk of market volatility.

The supply side is also putting pressure on the US Treasury market. The large US fiscal deficit means that the market needs to absorb a large amount of new Treasury bonds; at the same time, large technology companies are increasing debt financing for AI infrastructure investments, which is further driving up the demand for long-term funds.

More noteworthy is the changing buyer demographics. Research from the Federal Reserve Bank of New York shows a decline in participation from price-insensitive foreign official investors, while the role of hedge funds and private investors has increased.

Compared to the former, market-oriented investors such as hedge funds pay more attention to yields, prices, and financing conditions. When yields are high enough, these funds can absorb new government bonds; however, if the market adjusts rapidly, their positions may also change accordingly, making bond demand more flexible.

This means that with a continued increase in new supply and a decrease in stable buyers, the US Treasury market may need to attract funds through higher yields. If yields rise rapidly, falling bond prices could trigger stop-loss orders and margin calls, leading to passive selling and further amplifying market volatility.

Therefore, the current concern is not whether hedge funds will withdraw, but rather that the increased reliance of the US Treasury market on price-sensitive funds may amplify the impact of supply and demand changes on yields.

After 5%, what else should the market look at?

A 5% yield on 10-year US Treasury bonds is not the highest in history, but it is enough to prompt the market to reassess the long-term interest rate center.

A previous Bloomberg survey of market participants showed that more than half of respondents expected the yield on 30-year U.S. Treasury bonds to potentially reach 6% by the end of the year. This does not mean that 6% will definitely be achieved, but it reflects growing market concerns about continued increases in long-term interest rates.

At the same time, the 5% yield has increased the attractiveness of US Treasuries to long-term funds. Compared to the low-interest-rate environment following the financial crisis, US Treasuries now offer higher nominal returns, potentially prompting some funds to reallocate to fixed-income assets.

Therefore, the key factors going forward include not only inflation and the Federal Reserve, but also the scale of US fiscal financing and the market's ability to sustain the absorption of new Treasury bonds. If stable buyers continue to decrease while the proportion of price-sensitive funds further increases, the reaction of US Treasury yields to market shocks could be even more severe.

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