US Market: Four warning signs that bond selling could intensify

US Treasury yields have climbed sharply since the war with Iran began in February, raising concerns that sustained bond selling could further raise borrowing costs and amplify stress across financial markets.

The 10-year Treasury yield has risen about 135 basis points to 5.23%, while the 30-year yield has climbed around 110 basis points from its March low to 5.614%. Both yields are trading at levels last seen more than two decades ago, Reuters reported.

Investors are increasingly watching for signs that the selloff could gain momentum, with technical indicators pointing to the possibility of another sharp yield rise. Such a move could create a feedback loop in which higher yields prompt additional hedging and selling, further intensifying pressure on the bond market.


However, elevated yields could also attract investors seeking to lock in returns at levels not seen since the presidency of George W. Bush, potentially supporting Treasury prices.

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Reuters identified four key indicators suggesting that the recent bond market weakness could deepen

1. Demand for protection against rising yields is increasing

Investors are increasingly seeking protection against a further rise in interest rates through the options market, a trend known as payer skew. These instruments let investors hedge against sharp yield increases without necessarily selling their existing Treasury holdings.

The cost of insuring against a 200-basis-point increase in 10-year US swap rates over the next three months climbed to 132 basis points on Monday, its highest level since the March 2023 banking crisis triggered by the collapse of Silicon Valley Bank, Reuters reported.

Swap rates represent the fixed interest rate investors exchange for floating-rate payments. Although options are linked to swap rates rather than Treasury yields, the two generally move in tandem, making increased demand for protection a potential warning sign for government bonds.

Implied volatility, a key factor in options pricing, also rose to 21.4 basis points for one-month options on 10-year swap rates, the highest since late March. The increase indicates greater uncertainty about the direction of longer-term interest rates and heightened concern over further yield increases.

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2. Artificial intelligence investment is adding to bond market pressure

The rapid expansion of artificial intelligence infrastructure has emerged as another source of pressure on the Treasury market, as technology companies issue large amounts of debt to finance their investments.

According to Reuters, investors buying longer-dated bonds issued by AI hyperscalers are increasingly hedging interest-rate exposure through the Treasury market. Such hedging can involve selling Treasury futures, adding to downward pressure on government bond prices and pushing yields higher.

Some investors also sell Treasuries outright to free up capital for higher-yielding corporate debt, particularly when large investment-grade bond offerings come to market.

The scale of expected borrowing by technology companies could prolong the pressure. Goldman Sachs forecasts that AI hyperscalers could issue a record $420 billion in debt next year, Reuters reported, potentially generating additional hedging activity and further Treasury selling.

Although demand for corporate debt remains strong, the associated transactions could create a persistent source of selling pressure in government bonds.

3. Mortgage investors are stepping up hedging activity

Mortgage-related hedging is another factor that could exacerbate the Treasury selloff.

When interest rates rise, mortgage-backed securities can become more sensitive to further rate increases because the expected life of the underlying mortgages extends. Investors holding these securities may respond by increasing their interest-rate hedges, a strategy known as convexity hedging.

This process can involve selling Treasury futures, potentially reinforcing the broader decline in bond prices.

Reuters reported that investors remain exposed to a substantial volume of mortgages originated over the past three years at coupon rates relatively close to current mortgage rates. This could leave mortgage portfolios vulnerable to further yield changes and generate additional demand for hedging.

Recent large transactions also suggest mortgage investors are moving to protect their positions against market volatility. If yields continue to rise, further hedging could add another layer of selling pressure to an already unsettled Treasury market.

4. Steepening yield curve signals growing concerns over long-term debt

The widening spread between 10-year and 30-year Treasury yields is another warning sign for investors.

The 10-year/30-year yield spread widened to around 37 basis points this week as the 30-year yield rose faster than its 10-year counterpart, Reuters reported. The move suggests that investors are demanding greater compensation for holding longer-dated US government debt, Reuters reported.

Although the spread has been wider in the past, including when it reached 52 basis points in late July, the latest steepening is taking place with both yields already near multidecade highs.

This may indicate that investors are increasingly concerned about the risks associated with holding long-term debt, including the US fiscal outlook, rather than simply adjusting their expectations for Federal Reserve monetary policy.

The additional compensation investors demand for holding longer-term bonds is known as the term premium. A higher premium can push long-term yields higher even without a corresponding change in expectations for short-term interest rates.

Concerns about the long-term fiscal outlook could therefore remain a source of pressure on Treasury bonds, particularly at the longer end of the yield curve.

Outlook: Will higher yields attract buyers?

The combination of rising options-market protection costs, AI-related corporate borrowing, mortgage hedging and a steepening yield curve suggests that the Treasury selloff could face further pressure.

If these forces reinforce one another, additional selling could push yields higher, tightening financial conditions and increasing borrowing costs for governments, businesses and households.

However, the rise in yields could also create opportunities for investors seeking attractive long-term returns. Whether buyers step in at current levels will depend on their assessment of inflation, interest-rate expectations, fiscal risks and the potential for further market volatility.

For now, investors are watching whether elevated yields will attract fresh demand or whether growing hedging needs and concerns about long-term US debt will extend the selloff, Reuters reported.

(Disclaimer: This article is based on inputs from agencies. These do not represent the views of The Economic Times)