Long-term U.S. bond yields break through key support! Real interest rates hit a 16-year high, oil prices surge reigniting rate hike fears

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The U.S. Treasury market is experiencing a new round of sell-offs. Soaring oil prices and escalating tensions in the Middle East are once again pushing inflation risks to the center of the market. Long-term yields have broken key technical levels, and real interest rates have climbed to their highest levels since 2008.

On Tuesday, the U.S. 10-year Treasury yield rose to 4.64%, a near two-month high, surpassing the closely watched 4.60% technical barrier, and is currently trading around 4.63%. The 30-year yield also rose in tandem, with yields across maturities generally up 2 to 5 basis points. Meanwhile, the U.S. dollar strengthened against most major currencies.

Analysis indicates that the direct trigger for this round of selling was Brent crude prices rising to about $91 per barrel—both the U.S. and Iran have carried out strikes for ten consecutive days, and Yemeni Houthi forces continue to threaten Red Sea shipping routes. The sharp fluctuations in energy prices are again driving up inflation expectations.

Interest rate futures markets show that traders currently estimate the probability of the Federal Reserve raising rates at next week's policy meeting to be about 25%. Although this probability has declined from nearly "even odds" earlier this month, rate hike bets have quietly risen again in recent days as Middle East conflicts continues to escalate.

Notably, this round of bond market sell-offs has wiped out all the gains driven by last week's lower-than-expected inflation data, with the speed of this market sentiment reversal being alarming.

Oil prices are the core driver, technical level break magnifies the drop

Izaac Brook, RBC Capital Markets rate strategist, pointed out, "Today's market movement is mainly a direct reflection of the continued rise in energy prices."

He also emphasized that the drop in yields was further magnified due to breaking key technical levels—2-year yields returned above 4.20%, while the 10-year yield broke above 4.60%. The combination of thin summer trading conditions further intensified the volatility.

From a market structure perspective, shrinking trading volume is also one of the drivers of this volatility. According to CME Group’s open interest data, on Monday, SOFR futures and options trading volumes were only 74% and 54% of their 20-day averages, respectively. Below-normal liquidity has made prices more sensitive to directional impacts, amplifying unilateral moves.

Furthermore, this round of declines in long-term bonds is not solely driven by inflation expectations. The continued climb in real interest rates is also an important driver. On Tuesday, the 30-year Treasury Inflation-Protected Security (TIPS) yield—a proxy for real rates—rose to 2.95%, the highest since 2008.

Elevated real rates reflect strong market expectations for economic growth, rising capital costs, and expanding capital demand driven by ongoing government deficits and the investment frenzy in artificial intelligence.

Analysis believes this structural pressure means that, even if inflation data temporarily softens, long-term rates are unlikely to easily fall.

Federal Reserve decision path fraught with uncertainty

Regarding the outlook for Federal Reserve policy, the market still has significant divisions. Christopher Hodge, Chief U.S. Economist at Natixis, stated:

"As we have seen, energy price volatility is intense. The Fed’s decisions should be primarily guided by realized data, not just forecasts of overall CPI trends."

He also noted, "Under the new leadership, the Federal Reserve’s response function remains far from clear."

Analysis points out that this highlights the core dilemma facing the market: On one hand, the inflationary pressure from oil price shocks is real and persistent; on the other, the Fed’s policy direction under new leadership is unclear, making it difficult for investors to form stable expectations for the rate path.

The outcome of the Federal Reserve's policy meeting next week will be a key moment to test whether the market's pricing is reasonable.

Risk Warning and DisclaimerThe market has risks, investment needs caution. This article does not constitute personal investment advice nor consider specific investment objectives, financial situation or needs of any individual user. Users should consider whether any opinions, views or conclusions in this article suit their particular circumstances. If you invest based on this, you do so at your own risk. ```