(Sept 11): Yields on US government bonds rose to fresh multiyear highs as oil prices extended their surge, prompting traders to add to bets that the Federal Reserve will raise interest rates as soon as next week.

Treasury yields rose by five to 10 basis points (bps) across maturities, with the 30-year benchmark reaching levels last seen in 2007 and the two-year note yield exceeding 4.5% for the first time since 2024. Traders boosted expectations for a Fed rate hike next week to about 70% and fully priced in a move by October instead of December.

The 10-year note’s yield rose as much as nine basis points to 4.93%, last seen in November 2023. In treasury options trading, flows included the purchase for around US$14 million (RM56.93 million) of a put on the 10-year note futures contract, anticipating the corresponding yield will reach 5% by its Nov 20 expiration date.

“Crude oil drives inflation, and if it starts getting into the system it’s going to be hard to contain it,” said Tony Farren, managing director in rates sales and trading at Mischler Financial Group. “There’s no reprieve for yields to go lower if inflation remains elevated.”

Benchmark oil prices climbed more than 5% to the highest since May, advancing towards peak levels reached since the US attacked Iran in late February.

Rising energy prices hit government bond markets globally, with UK two-year yields climbing 17bps. Eurozone bond markets slumped after the European Central Bank (ECB) raised interest rates on Thursday by a quarter point to 2.5%, as expected. The second increase since the Iran war began was based on signs inflation will remain “well above target for an extended period,” the ECB said.

A US report on producer prices released on Thursday showed increases that were largely in line with economist expectations. Bond investors are more keenly interested in Friday’s consumer price index data as a determinant of what the Fed will do on Sept. 16.

“PPI data has only reinforced the case for tighter policy and, at the margin, gives the rise in yields a firmer fundamental footing. That said, some of it can be caveated by yet another sharp rise in oil. Either way, rates are repricing higher in what can only be classified as a global phenomenon,” says Brendan Fagan, macro strategist, Markets Live at Bloomberg Strategists.

The treasury selloff lifted the expected yield for an auction of 30-year bonds at 1pm New York time. The US$22 billion reopening of last month’s new issue had an indicated yield of about 5.35%, higher than 30-year auction results going back to 2001.

Shortly after the auction, the Treasury Department is slated to buy back as much as US$6 billion of debt in the 10- to 20-year sector, having increased the targeted amount from US$2 billion. The buyback expansion, unveiled in a surprise announcement on Aug. 19, is aimed at controlling the rise in long-term treasury yields.

The current buyback programme, begun in 2024, targets older securities that aren’t frequently traded. Its objective is to improve market functioning by concentrating issuance in more liquid instruments. 

There have been 25 operations targeting the 10- to 20-year maturity band since then, each for up to US$2 billion, with that amount accepted in each. Dealer offers to sell ranged from about US$7 billion to as much as US$36 billion — or 3.2 times to 18 times the amount accepted, with an average offer-to-cover of 9.6 times, Treasury Department data show.   

While rising oil prices have pressured the market, bond yields globally are also rising in response to growth in the supply of debt securities, both from governments financing deficits and from companies funding capital expenditures. 

Bank of America projected that net treasury supply will increase to about US$2.3 trillion in 2028 from US$1.9 trillion this year, in part because growth in the total debt caused annual interest expense to double over the past five years to more than US$1.2 trillion.  

Investor anxiety about US government spending has been stoked further by the prospect of a protracted war in the Middle East. A pledge by US President Donald Trump in a late-Wednesday speech to give all adult US citizens a US$5,000 dividend if Republicans retain control of both houses of Congress at the November mid-term elections — though viewed as unlikely to be kept — also was viewed as a threat to the fiscal outlook.

Meanwhile, investment-grade corporate bond sales set records in four of the past eight months, including the last three, and volume is tracking 7.6% above 2020 levels, when a record US$1.75 trillion was sold. A seasonal surge this week, predicted to total US$70 billion, had reached US$61 billion by Wednesday. 

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