US Treasury yields hit highest since 2007; four Fed officials signal possible rate hike

On Thursday (September 24), U.S. Treasury yields rose across the board, with both the 10-year and 30-year yields hitting their highest levels since 2007. Analysts at Bank of America noted that long-term bond yields have "recovered" to levels not seen since before the global financial crisis.

Fed Officials Sound Hawkish Tone

Four senior Federal Reserve officials delivered hawkish remarks:

• Patrick Harker, President of the Philadelphia Fed, stated that the Fed may need to raise interest rates again to lower inflation.
• John Williams, President of the New York Fed, said the U.S. economy has shown "remarkable resilience," but the Fed still has significant work to do in addressing price pressures.
• Loretta Mester, President of the Cleveland Fed, warned that inflationary pressures remain elevated, and the longer they persist, the more difficult it becomes to return inflation to target.
• Thomas Barkin, President of the Richmond Fed, pointed out that broad and persistent cost pressures increase the risk of inflation becoming entrenched.

Treasury Yields Surge

Yields on U.S. Treasuries rose sharply overnight:

• 2-year yield: +2.49 bps to 4.914%
• 3-year yield: +2.94 bps to 4.998%
• 5-year yield: +5.8 bps to 5.054%
• 10-year yield: +8.36 bps to 5.196%
• 30-year yield: +8.49 bps to 5.482%

Bank of America analysts noted that the government's net interest expense (debt servicing costs) is at a historic high and is projected to reach 3.3% of GDP by the second quarter of 2026. For context:

• In 2007, when the 10-year yield was around 5%, interest expenses accounted for only 1.7% of GDP.
• In 1991, when the 10-year yield peaked at around 7%, interest expenses were approximately 3.2% of GDP.

Implications for Markets

History suggests that Washington may only take fiscal discipline seriously after a further significant rise in Treasury yields. Continued increases in yields would place substantial pressure on equity markets.

According to a model by Jackson, Head of Global Asset Allocation Research at Invesco, if the 12-month moving average of the 10-year Treasury yield rises to 4.72% and continues upward, global stock markets could turn negative. The current 12-month average is approximately 4.34%, still below the model's threshold. Jackson has already moderately reduced equity exposure in favor of government bonds, warning that if yields keep climbing, the risk of pressure on equities over the next 12 months cannot be ignored.

Geopolitical Developments Provide Some Offset

Positive developments regarding Iran helped offset the upward pressure on Treasury yields. Multiple sources indicated that U.S. and Iranian negotiators are meeting in New York to explore a phased path to ending hostilities. The potential deal includes:

• Iran reopening the Strait of Hormuz
• The U.S. lifting economic sanctions on Iran
• Iran potentially regaining access to some frozen assets

The reopening of the Strait of Hormuz could serve as a key bargaining chip in the negotiations.

Ongoing Volatility Risks

The rate hike narrative continues to strengthen. Over the past 24 hours, four Fed officials delivered hawkish messages in succession, which could mean sustained volatility for equity markets.

According to LPL Financial data covering six rate hike cycles since 1994, the S&P 500's median decline in the three months following the first rate hike is 2.6%.

Lori Calvasina, Head of U.S. Equity Strategy at RBC Capital Markets, noted that in the past five cycles, the index's drawdown from its peak ranged between 8% and 14%. She cautioned: "The start of a new phase keeps us alert, and we should watch for a typical 5% to 10% pullback in the S&P 500 in the near term."

Historical Perspective on Recovery

However, historical data also shows that markets tend to recover relatively quickly. LPL data indicates that one year after the first rate hike, the S&P 500 has a median gain of 6.8%.

Jeffrey Buchbinder, Chief Equity Strategist at LPL Financial, noted that historically, equity markets are indeed nervous in the early stages of a rate hike cycle, but they tend to stabilize and return to focusing on economic and corporate earnings fundamentals.

Market analysts point out that the current rate hike cycle is expected to be relatively short and mild, in stark contrast to the 2022 cycle when 525 basis points of aggressive hikes sent the S&P 500 into a bear market with a 25% decline. Sam Stovall, Chief Investment Strategist at CFRA, noted that it was the magnitude of the 2022 rate hikes that frightened the market.

In comparison, futures markets currently price the peak of this cycle at around 4.8%, with total rate hikes of only about 100 basis points. Mona Mahajan, Head of Investment Strategy at Edward Jones, believes the current rate trajectory feels like a moderate mid-cycle adjustment that can still be absorbed given the state of the economy and labor market.