U.S. Treasuries Pressure Walsh: Hawkish Stance Alone Is Not Enough, Market Wants Rate Hikes

The U.S.-Iran conflict has driven up oil prices, raising inflation concerns and causing a significant surge in U.S. Treasury yields and a sharp decline in the stock market. Despite frequent hawkish statements from Federal Reserve Chairman Walsh, the market is no longer satisfied with mere verbal assurances. Currently, the probability of maintaining interest rates at this meeting is estimated at 62%, while the probability of a rate hike has surged from about 13% a week ago to approximately 38%. The Federal Reserve is facing dual challenges from high fiscal deficits and the bond issuance by tech giants.

Written by: Zhang Yaqi, Wall Street Insights

The U.S. Treasury market is sending a clear signal to Federal Reserve Chairman Walsh: strong rhetoric against inflation is far from enough to reassure investors.

The new round of military conflict between the U.S. and Iran that erupted in July caught Wall Street off guard, with international oil prices briefly surpassing $100 per barrel, triggering a massive sell-off in the $30 trillion U.S. Treasury market. The benchmark 10-year Treasury yield has risen by over 30 basis points since the end of June, reaching around 4.678%, close to a nearly ten-year high. Meanwhile, the 2-year Treasury yield, which is most sensitive to monetary policy, has also climbed to about 4.328%, surpassing the current 3.75% upper limit set by the Federal Reserve, reflecting strong market expectations for a rate hike.

On Wednesday, the Federal Reserve will announce its policy decision. According to the CME FedWatch Tool, as of last Friday, the market estimated a 62% probability of maintaining interest rates at this meeting, while the probability of a rate hike has surged from about 13% a week ago to approximately 38%.

"This shows how worried the market is about inflation and how concerned it is about whether the Federal Reserve can align its words with actions," said Gennadiy Goldberg, head of U.S. interest rate strategy at TD Securities, referring to Walsh's series of public statements about bringing inflation back to the 2% target.

Oil Price Shock Combined with Bond Market Pressure, U.S. Treasury Yields Near Ten-Year High

The U.S.-Iran conflict is the direct trigger for the recent rise in U.S. Treasury yields. The surge in oil prices has intensified market concerns about a resurgence of inflation, prompting traders to sell U.S. Treasuries aggressively. According to GasBuddy data, the average retail price of gasoline and diesel in the U.S. has recently returned to over $4 and $5.20 per gallon, respectively.

After Walsh held a press conference as Federal Reserve Chairman for the first time in June, the Treasury market briefly rebounded, but this upward momentum quickly dissipated. The 30-year Treasury yield has stubbornly remained above 5%, causing significant losses for investors who had bet on long-term bonds.

David Rosenberg, founder and president of Rosenberg Research & Associates, wrote in a report last Friday: "We did not anticipate this latest chapter of the U.S.-Iran war, which is a complex factor for any long-duration asset currently." He also noted that the continued expansion of bond issuance by tech-related companies is putting pressure on the Treasury market. Rosenberg stated that he has adjusted his portfolio, shifting from previously underperforming long positions in 30-year Treasuries to short-duration U.S. Treasuries.

Paul Christopher, head of global investment strategy at Wells Fargo Investment Institute, stated: "The Federal Reserve needs to heed this signal. Uncertainty is accumulating," as bond market investors demand appropriate compensation.

Rate Hike Window Controversy: The Cost of Policy Action and Timing Dilemma

The Federal Reserve is not a monolith. Some members of the rate-setting committee are inclined to use rate hikes to curb inflation. However, the issue lies in the extremely sensitive timing of any rate hike action.

Inflation itself erodes the real value of fixed-income assets, while rate hikes further depress bond prices and can drag down other financial assets such as stocks. Meanwhile, Barclays analysts expect the U.S. fiscal deficit to reach about $2 trillion in 2026, and the continued large-scale issuance of Treasuries will be an important way to fill this gap, which also means that supply pressure in the bond market is unlikely to ease in the short term.

Additionally, the large-scale borrowing by the tech industry is amplifying pressure on the bond market. Large tech companies, represented by "hyperscale cloud providers," are competing to issue corporate bonds to support AI infrastructure construction, driving up overall borrowing costs in the market. Moody's Ratings warned in a report last Wednesday that capital expenditures by these hyperscale cloud providers are expected to approach $1 trillion by 2027, following nearly $800 billion this year, and cautioned that "soaring capital expenditures, rising leverage, and off-balance-sheet commitments" will pose a threat to the credit quality of this group.

Stock Market Faces Further Decline, Tech Stocks Lead the Drop

The shadow of high rate hike expectations also looms over the stock market. Last week, semiconductor stocks led the decline, with the Philadelphia Semiconductor Index dropping over 4% for the week. The Dow Jones Industrial Average fell 0.4% for the week, the S&P 500 Index declined 0.6%, and the Nasdaq Composite Index saw a drop of as much as 2.1%. The Nasdaq Index's closing price has cumulatively fallen 7.8% from its historical high set in early June.

Higher interest rates often suppress corporate and consumer spending, which in turn slows economic growth and erodes corporate profit expectations. Christopher from Wells Fargo suggests that investors might consider waiting for this round of tech stock rotation to conclude, at which point "there may be a better entry opportunity," and he advises that "holding a certain amount of cash reserves may not be a bad idea."

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