The US Dollar Index rose by as much as 0.6% in a single day, expected to mark its best single-day performance since June 17.

Written by: Yang Chen, Wall Street Watch

The US Treasury market is undergoing a new round of intense selling, with the 10-year yield breaking 5% on Monday, reaching a new high for 2023. Concerns about inflation and supply pressures are resonating, putting pressure on global bond markets.

The 10-year yield peaked at 5.01% on Monday; the last time it surpassed 5% was in October 2023, and it only stayed there for a day before declining.

This time, the dollar strengthened concurrently, with the Bloomberg Dollar Spot Index rising by as much as 0.6% in a single day, expected to mark its best single-day performance since June 17, with all G10 currencies declining.

The continued rise in yields places dual pressure on the stock market and the economy. As the benchmark interest rate for global government and corporate debt, an upward movement in the 10-year US Treasury yield will raise borrowing costs, suppressing overvalued stock assets and dragging down economic growth.

The market has currently priced in a possibility that the Federal Reserve may initiate interest rate hikes as soon as September 16, with US Treasuries potentially recording their first annual loss since 2022.

Strategist predicting 5%: The sell-off is not over

Steven Barrow, the G10 strategist at Standard Bank who first made the 5% prediction in February this year, stated that the selling trend is far from over. He has raised his year-end forecast for the 10-year yield to 5.2% and expects it to further rise to 5.3% in the first quarter of 2027.

When Barrow made the 5% prediction in February, the market widely anticipated a series of rate cuts by the Federal Reserve, and the 10-year yield was below 4%, making his judgment highly contrarian. Now, the situation in Iran, shocks to energy prices, and inflation data have successively confirmed his outlook, further enhancing the convincing nature of his bearish stance.

He emphasized that long-term structural forces pushing interest rates upward— including global supply chain pressures, the ongoing impacts of climate change, and stricter immigration policies limiting labor supply—are becoming stronger than ever. Barrow stated:

"My assessment of the structural perspective is that we are in a regime of 'higher rates that persist for longer.'

He expects the Federal Reserve to raise rates once in September and December, then keep short-term rates unchanged until the end of 2027.

Rising inflation expectations trigger a new round of sell-off

The direct catalyst for this sell-off comes from multiple directions. Since the US initiated military action against Iran, energy supplies in the Middle East have been impacted, leading to a significant rise in oil prices, with WTI crude staying above $100 per barrel on Monday, causing inflation expectations to rise.

At the same time, August's Consumer Price Index data exceeded expectations, further solidifying the market's bets on Federal Reserve interest rate hikes.

With less than two months until the US midterm elections, the 10-year yield has increased by over a percentage point since the outbreak of the Iran war. Treasury Secretary Yellen previously took unconventional measures, such as increasing long-term Treasury buybacks, in an attempt to lower long-end rates, but the effects have been limited, and the selling momentum has not eased as a result.

Structural forces pushing up global long-end rates

This round of US Treasury sell-off is not an isolated phenomenon but reflects deeper structural pressures. The indicator measuring global government borrowing costs has risen to its highest level since 2007, as investors demand higher compensation to hold long-term debt, leading to an increasingly fierce capital competition between governments and corporations.

The US fiscal deficit continues to widen, with the Treasury market size expanding from about $4.5 trillion in 2007 to around $32 trillion today, and federal debt as a percentage of GDP has surpassed 100%.

Fitch Ratings has issued a warning, stating that the US's ability to withstand future economic shocks is declining. The boom in artificial intelligence infrastructure construction has led to a substantial new supply for the bond market, continuously injecting stimulus into the economy and further elevating bond market pressures.

Zach Griffiths, head of investment-grade and macro strategy at research firm CreditSights, stated, "There are many deep-rooted factors that make the continued rise in rates the path of least resistance right now." He believes the 10-year yield could further rise to 5.5%.

The dollar strengthens, but analysts have differing views on the future market

Rising US Treasury yields boost the dollar, but some strategists remain cautious about the sustainability of the dollar's upward trend.

Meera Chandan, co-head of global foreign exchange strategy at JPMorgan, pointed out that the dollar has lagged behind fundamentals in recent weeks. "High energy prices, strong inflation and employment data for August, coupled with Federal Reserve Chair Powell's hawkish statements at Jackson Hole, should have pushed the dollar stronger, but the actual performance has not kept pace."

She maintains a bullish stance on the dollar, particularly against low-yield currencies like the Swedish krona and the Canadian dollar.

Elias Haddad, head of global markets strategy at Brown Brothers Harriman & Co., warns that the dollar faces asymmetric risks—limited upside potential in a hawkish scenario, as the market has fully priced in approximately 100 basis points of rate hikes over the next 12 months; should a dovish surprise occur, the downside risks would be more pronounced.

In the options market, the one-month risk reversal indicator for the dollar index has returned to positive territory since September 2, indicating that traders are positioning for further dollar strength.