US two-year Treasury yields hit 17-month peak on Fed, oil surge
A global sovereign debt selloff and a resurgence in oil-driven inflation fears have pushed US two-year Treasury yields to a 17-month high, dramatically repricing expectations for Federal Reserve rate hikes.
US two-year Treasury yields climbed to 4.3105% on Wednesday, the highest level since February 2025, before settling at 4.298%. The benchmark 10-year yield rose to 4.6606%, its strongest level since May 20, narrowing the spread between the two maturities to just 35 basis points. The simultaneous rise in short- and long-dated borrowing costs signals broad stress across the world's largest bond market.
The move in the front end of the curve reflects a rapid reassessment of the Federal Reserve's policy path. Traders pricing fed funds futures now assign a 32% probability of a rate hike at the conclusion of the central bank's July 29 meeting. Those odds jump significantly to 76% by September and reach 90% by the end of the year, upending earlier bets for rate cuts.
Renewed geopolitical tensions are the immediate catalyst for the inflationary panic. Oil prices approached a six-week high after President Donald Trump vowed to destroy an Iranian bridge or power plant if ships are attacked in the Strait of Hormuz. This escalation follows threats from Iranian-allied Houthis in Yemen to target a second vital energy route.
However, the hawkish repricing extends beyond the immediate energy shock. Fed Governor Christopher Waller said last week the central bank may need to raise rates "in the near term" if inflation runs well above its 2% target. “Waller had a hawkish shift in tone, with an emphasis that was totally independent of energy pass-through,” said Will Compernolle, macro strategist at FHN Financial. “That set a new anchor for a hawkish policy trajectory that had nothing to do with how the war evolved.”
US debt is also absorbing spillover from fiscal anxieties in Europe. Rising gilt yields, driven by concerns over government spending under new British Prime Minister Andy Burnham, are dragging global sovereign debt lower. “The focus is on fiscal worries in Europe,” Compernolle said, adding that “there's just a general sell-off in global sovereign debt.”
Inflation expectations are climbing in tandem with nominal yields. Five-year Treasury Inflation-Protected Securities breakeven rates rose to 2.31%, up from 2.21% on June 24, indicating investors expect consumer prices to remain stubborn. Real yields are also surging, with 10-year TIPS hitting 2.375%, a peak not seen since the "tariff tantrum" of April 2025.
The combination of higher rates and inflation anxiety finally caught up with long-end demand. A $13 billion auction of 20-year bonds drew a bid-to-cover ratio of 2.64, below recent averages, forcing the Treasury to sell the debt at a high yield of 5.163%. The government will test investor appetite again on Thursday with a $21 billion sale of 10-year TIPS.
