The conflict between the US and Iran has pushed up oil prices and sparked inflation concerns, resulting in a surge in US bond yields and a sharp decline in the stock market. Despite frequent hawkish statements from Federal Reserve Chairman Waller, the market is no longer satisfied with verbal statements; currently, the probability of maintaining interest rates unchanged at this meeting is 62%, but the probability of a rate hike has risen sharply from about 13% a week ago to around 38%. The Federal Reserve is facing a dual challenge from high fiscal deficits and debt issued by tech giants.

By: Zhang Yaqi, Wall Street Insights

The US Treasury market is sending a clear signal to Federal Reserve Chairman Waller: tough rhetoric against inflation is far from sufficient to soothe investors.

The new round of military conflict between the US and Iran that erupted in July caught Wall Street off guard, with international oil prices briefly exceeding $100 per barrel, again triggering a massive sell-off in the $30 trillion US bond market. The benchmark 10-year US Treasury yield has risen by more than 30 basis points since the end of June, to around 4.678%, approaching a nearly ten-year high. Meanwhile, the 2-year US Treasury yield, which is most sensitive to monetary policy, has climbed to about 4.328%, breaking through the current 3.75% upper limit set by the Federal Reserve, reflecting strong market expectations for interest rate hikes.

On Wednesday, the Federal Reserve will announce its policy decision. According to the CME FedWatch Tool, as of last Friday, the market expected a 62% probability that interest rates would remain unchanged at this meeting, but the probability of a rate hike rose sharply from about 13% a week ago to approximately 38%.

This illustrates how worried the market is about inflation and how concerned it is about whether the Federal Reserve can align its words and actions," said Gennadiy Goldberg, head of US interest rate strategy at TD Securities, referring to Waller's public expressions regarding bringing inflation back to the 2% target.

Oil Price Shock Coupled with Debt Market Pressure, US Treasury Yields Approaching Ten-Year Highs

The US-Iran conflict is the direct trigger for the recent rise in US Treasury yields. The surge in oil prices has heightened concerns about the return of inflation, prompting traders to sell US Treasuries aggressively. According to GasBuddy data, the recent retail prices for regular gasoline and diesel in the US have returned to over $4 and $5.20 per gallon, respectively.

After Waller held his first press conference as Federal Reserve Chair in June, the US bond market briefly rebounded, but this upward momentum quickly evaporated. The 30-year US Treasury yield has stubbornly remained above 5%, causing significant losses for investors who had previously bet on long bonds.

David Rosenberg, founder and president of Rosenberg Research & Associates, wrote in a report last Friday, "We did not anticipate this latest chapter in the US-Iran conflict, which is a complex factor for any duration asset currently." He also pointed out that the continued expansion of debt issuance by technology-related companies puts further pressure on the US bond market. Rosenberg stated that he has adjusted his portfolio, shifting from previously underperforming long positions in 30-year Treasuries to short-duration US Treasury bonds.

Paul Christopher, head of global investment strategy at Wells Fargo Investment Institute, said, "The Federal Reserve needs to listen clearly to this signal. Uncertainty is building up," as bond market investors are demanding appropriate compensation.

Interest Rate Hike Controversy: The Cost of Policy Action and Timing Dilemma

The Federal Reserve is not of one mind. Some members of the rate-setting committee favor raising interest rates to curb inflation. However, the issue is that the timing of any rate hike is extremely sensitive.

Inflation itself erodes the real value of fixed-income assets, while interest rate hikes would further depress bond prices and weigh on other financial assets, such as stocks. Additionally, Barclays analysts expect the US fiscal deficit for 2026 to reach about $2 trillion, with the continued massive issuance of US Treasuries being an important way to fill the gap, which also means that supply pressure in the bond market is unlikely to ease in the short term.

Moreover, the massive borrowing by the technology sector is amplifying pressure on the bond market. Large tech companies, represented by "hyperscale cloud providers," are competing to issue corporate bonds to support infrastructure construction for artificial intelligence, pushing up overall borrowing costs in the market. Moody's Ratings predicted in a report last Wednesday that these hyperscale cloud providers' capital expenditures will approach $1 trillion by 2027, following nearly $800 billion this year, and warned that "soaring capital expenditures, rising leverage, and off-balance-sheet commitments" pose a threat to the credit quality of this group.

The Stock Market Faces Renewed Declines, Tech Stocks Lead the Drop

The shadow of high interest rate expectations also looms over the stock market. Last week, semiconductor stocks faced significant declines, with the Philadelphia Semiconductor Index dropping over 4% in a week. The Dow Jones Industrial Average fell 0.4% over the week, the S&P 500 Index dropped 0.6%, and the Nasdaq Composite Index saw a decline of 2.1%. The Nasdaq index’s closing price has cumulatively retreated 7.8% from the historic high set in early June.

Higher interest rates often suppress corporate and consumer spending, thereby dragging down economic growth and eroding corporate profit expectations. Christopher from Wells Fargo suggested that investors might wait until this round of rotation in tech stocks comes to an end, at which point, "there may be a better entry point," and noted that "holding a certain cash reserve may not be a bad thing."