The 10-year US Treasury yield has broken through 5%! Two narratives are swirling in the market: a "2023-style temporary peak" or a "2000s-style financial crisis"?

The yield on the 10-year U.S. Treasury bond, a benchmark for trillions of dollars in global assets, surged to 5% following the Iran war, a point widely considered a worrying tipping point. Aside from a brief rise to 5% in 2023, the last time the 10-year Treasury yield hovered above 5% was just before the global financial crisis.

Overnight, the 10-year US Treasury yield rose to 5.012% intraday, its highest intraday level since 2007, before falling back to close at 4.960%. This key threshold is forcing investors to confront a core question: Is the bond market entering a new era?

There are currently two diametrically opposed narratives in the market. One view holds that 5% will be a temporary peak, similar to October 2023, after which yields will fall back. The other worries that yields will decisively break through this threshold, repeating the pattern of prolonged high yields seen in the 2000s and even the 1990s. The answer will have a profound impact on borrowing costs for consumers, businesses, and even the US government, and may influence the outcome of the upcoming midterm elections.

The impact of war combined with inflationary pressures has pushed yields to a critical threshold.

The immediate trigger for this round of yield increases was the surge in energy prices caused by the continued escalation of tensions in the Middle East. Brent crude oil jumped nearly 9% last week after the Iranian-backed Houthi rebels gained control of another key shipping route off Yemen's west coast. As of Monday, Brent crude was up slightly by 1%, trading at $105.68 a barrel.

Rising energy prices have reinforced market expectations of persistently high inflation. Stronger-than-expected inflation data released on Friday has led investors to almost unanimously anticipate a rate hike by the Federal Reserve at its meeting this Wednesday, followed by further tightening of monetary policy. Trump's repeated public calls for a rate cut by the Fed have put Fed Chairman Warsh in a dilemma, while market expectations for a rate hike continue to climb.

The 10-year Treasury yield is a key driver of interest rates in the economy, and its recent rise has pushed mortgage rates back up to near 7%. Treasury Secretary Scott Bessent has previously taken unconventional measures to try to suppress yields, but with little success so far.

Two historical scenarios, different perspectives from the market

Monday's trading session reminded some investors of October 23, 2023, when the 10-year yield also touched 5% in the morning before falling sharply to above 4.8% later in the day, demonstrating typical investor behavior of rushing to buy bonds after this milestone was reached.

However, the magnitude of this correction is significantly smaller than that of 2023, leading many investors to believe that it is not impossible for yields to easily break through 5% in the coming weeks or even months.

"I've been asking myself, 'Okay, what would be the catalyst for lower interest rates?' It's hard to find an answer other than a recession. Current conditions are very favorable for yields to remain high or even rise further," said Greg Peters, co-chief investment officer at PGIM Credit.

On the other hand, Meghan Swiber, senior U.S. interest rate strategist at Bank of America, holds a different view: "If the Fed raises rates this week and signals that it will do whatever it takes to control inflation, we believe this will actually help to lower long-term interest rates."

Debt size and supply pressure provide structural support for rising yields.

Some investors believe that the current rise in yields reflects, to some extent, the normalization of the economy—a return to the state before the 2008 financial crisis, before the era of large-scale central bank bond purchases and ultra-low interest rates.

However, the current situation also has its unique aspects. The total U.S. federal debt recently surpassed $40 trillion, doubling in size compared to a decade ago. This increased debt means a greater supply of Treasury bonds, potentially depressing bond prices and pushing up yields. Under Bessant's leadership, the Treasury has recently begun to increase its repurchase of long-term bonds, but these purchases remain negligible relative to the total stock of Treasury bonds.

Representative David Schweikert (Republican, Arizona) wrote on social media Monday: "Today's numbers should terrify Congress."

The AI boom and stock market prosperity partially offset the impact of high interest rates.

Several analysts pointed out that the stock market boom driven by AI investment enthusiasm has, to some extent, buffered the impact of high returns on the economy.

AllianceBernstein Chief Economist Eric Winograd stated, "Typically, higher yields and borrowing costs could dampen corporate investment. But many tech companies now see investing in AI as a life-or-death strategic choice. I think their response to financial conditions is drastically different from other companies."

This factor has led to a relatively optimistic market view on whether the economy can withstand a 5% yield without a rapid slowdown, and has also given more support to the narrative that "yields will remain high for a long time."

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