US 30-Year Treasury Yield Hits 5.20% as Fed Hike Odds Rise

Inflation fears tied to the Iran war drive bond selloff

Strait of Hormuz disruption spreads to food and airfares

62% of fund managers see US 30-year Treasury yields rising to 6%

Chances of a Fed rate hike are also increasing

Long-term US Treasury yields have surged to their highest levels in 19 years. A jump in energy prices tied to a prolonged war with Iran, combined with concerns over widening fiscal deficits, has fueled a broad selloff across global bond markets.

On May 19, the yield on the 30-year US Treasury rose as high as 5.2% intraday, its highest level since 2007. Bond prices and yields move in opposite directions.

The yield on the 10-year US Treasury, which influences US mortgage rates, also climbed to about 4.67%, the highest in more than a year. The 10-year yield had been below 4% before the outbreak of the Iran war, but recently approached 4.7% as the bond selloff accelerated.

Concern that inflation will remain elevated has been a key driver of the move higher in yields. International oil and natural-gas prices have jumped to their highest levels in four years since the war with Iran began. The fallout from the closure of the Strait of Hormuz is also spreading through the broader economy, including food prices and airfares.

A May survey of global fund managers released by Bank of America on May 19 showed that 62% of respondents expect the 30-year US Treasury yield to rise to 6%. By contrast, only 20% said the 30-year yield would fall to 4%.

Another factor behind the rise in Treasury yields was a sharp reduction in US debt holdings by foreign countries including China and Japan in March. Data released by the US Treasury Department on May 19 showed China's Treasury holdings fell to $652.3 billion in March, down about 6% from the previous month and the lowest since September 2008. Japan, the largest foreign holder of US Treasuries, cut its holdings by $47 billion to $1.191 trillion.

The main reason is believed to be that central banks sold dollar-denominated assets to defend their currencies after the outbreak of war in the Middle East and the subsequent spike in oil prices sent Asian currencies including the yen sharply lower.

"It is not surprising that central banks' holdings of US Treasuries have declined as financial volatility increased after the war and foreign-exchange pressure intensified in Asia," Frederic Neumann, HSBC's chief Asia economist, said.

The US two-year Treasury yield also rose to its highest level in more than a year. That suggests markets have abandoned expectations for a Fed rate cut and are beginning to price in the possibility that rates will stay on hold or rise again.

Expectations are also growing that the Federal Reserve could raise rates this year. CME FedWatch showed on May 19 that interest-rate futures markets were pricing in a 41.4% chance of a 25-basis-point rate increase by December. A month earlier, that probability was zero. The probability of rates staying unchanged fell to 40.3% from 49.3% a month earlier. The chance of a rate cut disappeared.

Kevin Warsh, who is due to take office as the next Fed chair on May 22, also faces an environment that would make it difficult to lead rate cuts. At last month's Federal Open Market Committee meeting, three regional Fed presidents supported keeping rates unchanged but opposed including a dovish-bias phrase in the policy statement that would have signaled rate cuts.

Park Shin-young, New York correspondent, Korea Economic Daily nyusos@hankyung.com