The latest U.S. inflation data has reignited market concerns, leading to a fresh wave of selling in U.S. Treasury markets. Data released by the U.S. Labor Department showed that the Consumer Price Index (CPI) accelerated in April, driven by rising oil and food prices. This has strengthened market expectations that the Federal Reserve will maintain high interest rates for an extended period, with some even anticipating another rate hike. According to the CME FedWatch Tool, the market-implied probability of a 25-basis-point rate hike in December has surged to over 30%, a significant jump from 21.5% the previous trading day.
Traders are swiftly rebuilding short positions in U.S. Treasuries. Steven Barrow, Head of G10 Strategy at Standard Bank and a seasoned bond market veteran, has predicted that the yield on the 10-year U.S. Treasury note will surpass 5% this year. This would represent an increase of over 50 basis points from current levels and is more than 80 basis points above the average year-end forecast from Bloomberg strategists. Kelsey Berro, a Fixed Income Portfolio Manager at J.P. Morgan Asset Management, noted that the current market pricing reflects a view of a resilient economy, allowing the Fed to remain on hold for a considerable time.
The renewed selling pressure is particularly pronounced at the short end of the yield curve. On Monday, yields across major Treasury maturities rose by approximately 5 basis points. The 5-year yield further solidified its position above 4%, triggering a rapid accumulation of short positions. The 30-year Treasury yield surged back above 5.00%. A J.P. Morgan client survey as of May 11 indicates that bearish sentiment in the Treasury market is rising, with investors' net short positions reaching a 13-week high. David Bieber, a strategist at Citi, observed that bearish sentiment is rebuilding alongside rising yields, with increased short risk exposure in both the SOFR front-end and the belly of the yield curve.
John Briggs, Head of North America Rates Strategy at Natixis, pointed to ongoing geopolitical conflicts, stating that the duration and severity of inflationary shocks remain uncertain. He suggested that resolving such conflicts is key to understanding when pressure might ease; otherwise, prolonged tail risks could reduce the likelihood of rate cuts and increase the risk of oil-driven inflation spreading to other sectors.
The rekindled expectations for rate hikes are also evident in the options market. In the Secured Overnight Financing Rate (SOFR) options market, traders are actively seeking to hedge against the risk of further rate hike expectations being priced in over the coming weeks. As a market closely tied to Fed policy expectations, Monday's trading saw demand for put options pricing in two additional hikes by the end of 2026. The current options positioning shows a clear divergence: the September contract is driven by call options (reflecting residual bets on rate cuts), while the December contract is driven by put options, indicating hedging against a high-rate environment or the risk of inflation rebounding by year-end.
Amidst a consensus among most strategists that the 10-year yield will end the year between 4% and 4.5%, veteran bond trader Steven Barrow stands by his prediction, made early this year, that it will break 5%—a key psychological level not sustainably exceeded since 2007. On Wednesday, the 10-year yield was around 4.462%, a significant rise from the 3.94% level before recent geopolitical events. Barrow stated that while disruptions in the global energy market due to Middle East conflicts have reinforced his view, they are not its origin. He cited several supply-side inflationary drivers, including global supply chain pressures, ongoing climate shocks, and restricted labor supply due to tighter immigration policies. He believes Fed policy may be too accommodative and is pessimistic about the government's willingness for fiscal consolidation.
Barrow acknowledges his prediction is an outlier from the consensus, attributing this partly to his independent research model. He suggests that large research teams often require lengthy debates to adjust forecasts, leading to a "mean reversion bias" and more conservative, smoothed predictions. If the 10-year yield does break 5%, Barrow warns the impact would extend far beyond the bond market, potentially heightening concerns over U.S. debt sustainability, raising global corporate borrowing costs, and triggering a rotation of funds from equities to bonds. While the 10-year yield has so far failed to sustainably break 4.5% this year, and the 30-year yield has often attracted contrarian buying near 5%, Barrow does not see this as a sign of a top, arguing that past failure to hold above 5% does not preclude future success.
Regarding arguments from bond bulls and some policymakers that artificial intelligence will significantly boost productivity, thereby creating room for easier monetary policy, Barrow expresses clear skepticism. Having witnessed multiple technological revolutions that promised much but delivered less, he is reluctant to overprice this narrative.
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