10-year Treasury yield in the United States briefly rose above the 5% mark on Monday, a level not seen since 2023, as oil prices surged amid the protracted conflict involving Iran and disruptions to key shipping lanes.
Oil market turmoil fuels bond market reaction
Brent crude jumped more than 4% to near $110 a barrel, the highest price since May, after reports that the Strait of Hormuz remains partially blocked and that Houthi rebels have taken control of the Bab al-Mandab Strait. A drone strike also halted Saudi Arabia's East-West Pipeline, further tightening supplies.
These developments have pushed global oil and refined product prices higher, feeding into inflation expectations and prompting bond yields across Europe and Asia to climb in tandem with US Treasuries.
Why higher yields matter for debt-laden economies
According to Neil Shearing, group chief economist at Capital Economics, the rise in yields signals a shift in how policymakers view supply-shock inflation.
After several years in which inflation has run above target, it has become harder for policymakers to "look through" the otherwise temporary effects of higher inflation caused by supply shocks.
He added that in an environment of high public debt and large fiscal deficits, a feedback loop through the bond market could exacerbate fiscal pressures.
More importantly, in a world of high public debt and large fiscal deficits, there is a potential feedback loop through the bond market that could make a difficult situation considerably worse.
Higher borrowing costs increase the expense of servicing sovereign debt, potentially crowding out other spending and raising the risk of a self-reinforcing cycle where rising yields fuel fiscal worries, which in turn push yields higher.
Implications for the Federal Reserve and the tech sector
The timing coincides with expectations that the Federal Reserve will raise rates on Wednesday, a move likely to be mirrored by other central banks. A sustained 5% yield could also weigh on technology stocks, particularly chipmakers that have benefited from the AI boom.
In a recent Financial Times op-ed, Ruchir Sharma, chairman of Rockefeller International, warned that the AI bubble could burst if the 10-year yield decisively breaches 5%.
AI bubble could pop when the 10-year yield "decisively breaches" 5%.
Sharma noted that debt-servicing costs are now higher than they have been in decades, meaning that rising public borrowing costs could squeeze other borrowers and dampen the AI-driven market rally.
What comes next?
Analysts expect the yield to retreat from its peak, but the episode underscores how vulnerable heavily indebted economies are to supply-side shocks. If oil prices remain elevated, policymakers may face limited room to manoeuvre, and markets could see further volatility ahead of the Federal Reserve's decision.
For now, US nominal GDP growth still outpaces debt-service costs, but the episode serves as a reminder that a world laden with debt is more exposed to shocks that can amplify through the bond market.