US Yields at 5% Tug Traders Between Dip-Buying Greed and Fear

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The 10-year US break-even rate, which signals bond investors’ expectations of inflation over the coming decade, has risen almost 20 basis points since the conflict began, while Brent crude oil jumped 40%.

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With the Strait of Hormuz still closed and oil around $100 a barrel, traders are wagering that policymakers in the UK and Europe will need to start raising rates to contain the impact. 

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In the US, overnight-indexed swaps were pricing in a 43% likelihood of a Fed rate cut by March next year just three weeks ago, but they now signal more than a 20% chance of a hike. Expectations largely held even as bond yields pulled back slightly on Wednesday on revived hopes of a Middle East peace deal. 

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“Even if the Strait is reopened, any initial relief rally may be short-lived,” said John Canavan, an analyst at Oxford Economics. “It will take significant time for oil production to return to normal.” 

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The US isn’t alone in seeing a rising cost of borrowing. Strategists at National Bank of Canada estimate the average of 10- and 30-year yields across the Group of Seven countries ended April at a 17-year high, while the Blackrock Investment Institute is declaring “higher yields are here to stay.”

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Despite the selloff in bonds, the US stock market has rallied to new record highs as the AI spending boom and strong corporate earnings overshadowed the Middle East risks and a slowdown in the job market. 

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But Bank of America Corp. strategist Michael Hartnett is telling clients that a sustained push in the 30-year yield above 5% is a point at which “the door to doom starts to open,” warning that bubbles often end with a sharp jump in yields. 

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A key question for traders is whether the recent episode will mirror what happened at the peak of the Fed’s rate hikes in late 2023 and again after the market meltdown caused by Trump’s tariffs in the middle of last year. 

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In both cases, the 30-year yield only briefly held over 5%, delivering big gains to investors who bought at those peaks. A similar dynamic could play out again if a US-Iran deal means the oil shock fades or if the economy stalls, reviving bets on Fed rate cuts.  

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“We think market pricing remains too hawkish,” Krishna Guha, vice chairman at Evercore ISI, wrote in a report to clients. “A deal with oil moving lower is consistent with Fed cuts delayed not derailed.”

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What Bloomberg’s Strategists Say…

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“Long-bond yields have nudged back below 5% but remain extremely elevated by the standards of recent history, particularly given Fed policy over the past couple of years. Yields probably need a Fed hike to stick around here.”

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— Cameron Crise, MLIV macro strategist

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Still, a disorderly rise in the 10-year Treasury yield through 5% typically doesn’t bode well for the globe’s economies or stocks. 

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Such a breach was followed by US recessions in 2001 and 2007, or at least triggered bouts of volatility in equities. 

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During the most recent occurrence, in 2022, the MSCI World Index experienced a 27% drawdown as yields climbed to 4% fast, before recovering most losses as rates stabilized. Yet, as yields made their way to the 5% threshold in 2023, the benchmark saw an 11% drop over a three-month time frame.

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Ed Al-Hussainy, portfolio manager at Columbia Threadneedle Investments, is among those who have been buying the longest-dated Treasuries to seize on the recent move, but even he has reservations. 

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“I’m very nervous,” he said. “The US growth story is better than it was six months ago and versus expectations at the beginning of the year, so it puts a higher floor under rates.”