Deficits, Inflation, and the New Federal Reserve: The Deep Logic Behind U.S. Treasury Yields Breaking 5% and Market Reset

Key Data: 10-year yield 4.61% to 4.687% · 30-year yield 5.2%, the highest since 2007 · S&P 500 index has fallen for three consecutive days · Warsh confirmed as the new Federal Reserve Chairman · The "One Big Beautiful Bill" is expected to increase the deficit by $2.8 trillion · 62% of fund managers expect the 30-year yield to reach 6%

Section One --- What is Happening Now

In the week of May 15 to 19, 2026, U.S. long-term Treasury yields soared to their highest levels in years. The 10-year U.S. Treasury yield climbed to 4.61% on May 18, reaching a one-year high, and further increased to 4.687% on May 19. The 30-year U.S. Treasury yield surged to 5.2%, the highest level since 2007. The S&P 500 index fell more than 1% on May 15 and dropped another 0.67% on May 19, marking the third consecutive trading day of losses. The Nasdaq index fell 0.90%, and the small-cap Russell 2000 index dropped 1.33%.

Multiple factors are converging simultaneously. Inflation data exceeded expectations. Wholesale prices rose 6% year-on-year in April, marking the highest upstream inflation pressure in years. The trajectory of U.S. debt continues to deteriorate. A new Federal Reserve Chairman is taking over one of the most complex inflation situations in years. A massive tax cut bill is expected to add trillions to the national debt over the next decade.

The bond market is loudly signaling, and the stock market is finally starting to listen.

Educational Note: U.S. Treasury yields are the rates paid by the U.S. government to borrow money. When yields rise, it means the government must pay higher interest to attract creditors—either because investors demand higher risk compensation or because the supply of bonds exceeds market demand.

Section Two --- Four Reasons for Rising Yields

Reason One: Stubborn Inflation

The April inflation data released on May 15 exceeded market expectations, directly triggering an immediate surge in yields. Wholesale prices rose 6% year-on-year in April, marking the highest upstream inflation record in years, indicating that price pressures are not only reflected at the consumer level but are also being transmitted throughout the supply chain.

Since September 2024, the Federal Reserve has cumulatively cut rates by 175 basis points—100 basis points in the second half of 2024 and another 75 basis points in the second half of 2025. Typically, long-term yields should decline accordingly. However, the reality is quite the opposite: the 10-year yield has only decreased by about 35 basis points, while the 30-year yield has risen to 5.2%. Mark Malek, Chief Investment Officer at Sibert Financial, bluntly stated in a widely circulated article that this divergence is "unprecedented": "Historical data dating back to 1990 shows that there has never been such an abnormal disconnection between Fed policy and long-term yields."

Current market pricing indicates that the probability of a rate hike before December 2026 has risen to 48%, up from just 14% a week ago. The probability of a rate cut is now below 1%. The bond market's expectations are no longer about "pausing rate cuts," but rather starting to price in "returning to rate hikes."

Reason Two: New Federal Reserve Chairman Takes Over a Crisis

On May 13, 2026, the U.S. Senate confirmed Kevin Warsh as the new Federal Reserve Chairman by a vote of 54 to 45, making it the most controversial confirmation vote in the history of the Federal Reserve. His term officially began on May 15 when Jerome Powell's term ended. Powell chose to remain a member of the Federal Reserve Board.

When Warsh took over, U.S. inflation had exceeded the Federal Reserve's 2% target for more than five consecutive years, energy prices remained high due to ongoing U.S.-Iran conflicts, and the bond market was calling for a clear return to fiscal discipline. JPMorgan now expects the Federal Reserve to maintain interest rates throughout 2026, with the earliest possible rate hike of 25 basis points in the third quarter of 2027. Warsh stated during his confirmation hearing that the Federal Reserve needs a "different inflation response framework." His first Federal Open Market Committee (FOMC) meeting is scheduled for June 16-17, and every statement made then will impact the market.

Reason Three: Escalating U.S. Debt Issues

The U.S. annual fiscal deficit is about $2 trillion, with interest payments on existing debt nearing $1 trillion per year. The Treasury Department expects to borrow $189 billion in the second quarter of 2026, exceeding previous forecasts by $79 billion. The actual borrowing amount in the first quarter of 2026 was $577 billion, with an expected borrowing of $671 billion in the third quarter.

Every bond must find an investor willing to buy it. When market supply exceeds natural demand, the only mechanism to restore balance is higher yields. The International Monetary Fund has warned that the "safe haven premium" of Treasury bonds—i.e., the extra demand they enjoy as the world's safest asset—is fading. Once the safe premium disappears, yields will inevitably rise to fill the gap.

Reason Four: The "One Big Beautiful Bill" and Moody's Downgrade

The "One Big Beautiful Bill" (OBBB), signed into law in 2025, permanently extends the tax cuts from Trump's first term and adds new tax provisions. The Congressional Budget Office estimates that this bill will increase the fiscal deficit by $2.8 trillion over the next decade. If all temporary provisions become permanent, the Responsible Federal Budget Committee estimates the cost could reach $4 to $5 trillion.

On May 16, 2025, Moody's downgraded the U.S. sovereign credit rating from Aaa to Aa1, becoming the last of the three major rating agencies to downgrade the U.S. rating. S&P completed its downgrade back in 2011, and Fitch followed in 2023. Moody's cited the failure of successive governments to effectively address the ongoing rise in deficits and interest costs. It is expected that by 2035, federal interest payments will account for 30% of federal revenue, up from 18% in 2024 and just 9% in 2021.

A Bank of America survey released on May 19 showed that 62% of global fund managers expect the 30-year Treasury yield to eventually reach 6%, the most pessimistic consensus in the bond market since the end of 1999. The term "bond vigilante" has returned to market discourse—this concept was coined by Wall Street veteran Ed Yardeni in the 1980s to describe those who sell bonds to punish fiscal profligacy, pushing yields higher to force the government to confront fiscal issues. Today's version of the "bond vigilante," as Malek puts it, is engaging in "a slow and systematic pressure campaign."

Educational Note: The yield curve refers to the graphical relationship between yields of government bonds of different maturities. When long-term yields rise much faster than short-term yields, it is referred to as a "bear steepener." This typically indicates that investors are worried about long-term inflation and fiscal sustainability, even if short-term policy rates remain relatively stable.

Section Three --- Why Rising Yields Impact the Stock Market

Rising yields exert pressure on the stock market through four different channels.

Channel One: Discount Effect

The value of each stock equals the present value of all its future earnings discounted to today. The higher the discount rate, the lower the present value. Rising yields directly increase the discount rate, with the most significant impact on high-growth tech stocks, as much of these companies' value comes from future earnings that will not materialize for years. 2022 serves as the best reference: the 10-year yield soared from 1.5% to 4.3%, and the Nasdaq index fell 33% cumulatively, with Nvidia's stock halving by over 50%. Most of this loss came from a compression of valuation multiples rather than a deterioration in earnings. The pace in 2026 is more gradual, but the mechanism is the same.

Channel Two: Competition Effect and Equity Risk Premium

When the risk-free government bond 30-year yield reaches 5.2%, stocks must provide returns far above this to persuade investors to take on additional risk. Currently, the earnings yield of the S&P 500 is about 4.2%, while the 10-year Treasury yield is 4.6%. This means that the returns investors are getting from stocks are actually lower than those from risk-free Treasuries—an unusual and unsustainable state. The equity risk premium has been compressed to nearly zero. Historical patterns indicate that this state will ultimately be corrected through either a decline in stock prices or a retreat in yields. However, currently, yields have not retreated.

Channel Three: Borrowing Cost Effect

When Treasury yields rise, the borrowing costs for the entire economy also increase. As of mid-May 2026, the fixed mortgage rates for 30-year loans have risen to between 6.34% and 6.54%. Corporate financing costs are rising, and consumer spending on housing, cars, and credit cards is being suppressed. The signals from the bond market ultimately reach every household and every corporate balance sheet.

Channel Four: Strong Dollar and International Capital Flow Effect

Rising U.S. yields attract global capital to dollar assets, pushing up the dollar exchange rate and putting pressure on the overseas earnings of U.S. multinational companies in terms of conversion. For Asian investors, capital flowing to the U.S. will create pressure on Asian currencies, real estate investment trusts (REITs), and income-generating assets. This round of rising yields has a global resonance: the 10-year yield in the UK has surpassed 5.1%, the yield on Japanese government bonds has risen to 2.71%, the highest since 1997, and German bond yields have also climbed. When global bonds are collectively sold off, the pressure on the stock market is amplified everywhere.

Educational Note: The equity risk premium is the extra return that investors require from stocks relative to the risk-free rate. Currently, the S&P 500 earnings yield is about 4.2%, while the 10-year Treasury yield is 4.6%, indicating that stocks are technically less attractive than bonds. This compressed premium state has historically often been a leading signal of stock market weakness, as capital tends to flow toward higher-yielding, lower-risk assets.

Section Four --- Impact on Different Types of Investors

Stock Investors

The current environment is particularly unfavorable for high-valuation growth stocks. Banks, insurance companies, and value-oriented cyclical stocks tend to perform relatively better in a rising yield environment, as wider net interest margins benefit financial stocks. Tech stocks, real estate investment trusts, and utility stocks face the most pressure.

Bond Investors

Note: Short-term bonds currently offer attractive yields of around 4% to 4.5%, with lower price volatility risk. Most analysts prefer medium-term bonds with maturities of 5 to 10 years, viewing them as the best balance between yield and risk management. Long-term bonds with maturities of 20 to 30 years face the greatest price downside risk if yields continue to rise.

Income Investors

Are experiencing the most attractive fixed-income environment in over a decade. The 10-year Treasury yield at 4.6% represents a tangible fixed income opportunity. Investment-grade corporate bonds offer spreads above Treasuries, providing even more generous returns. For investors holding to maturity, the appeal of locking in current yield levels far exceeds any opportunities from 2020 or 2021.

Section Five --- Key Developments to Watch

Warsh's First FOMC Meeting, June 16-17. This is the most important upcoming event. Any statement he makes regarding policy direction—whether tolerating inflation or leaning toward tightening—will have a significant impact on both the bond and stock markets.

U.S. Inflation Data. The monthly CPI and PCE data will determine whether rate hike expectations will be further reinforced. Wholesale prices have already risen 6%, indicating that upstream pressures have not eased.

U.S. Treasury Bond Auction Results. Weak demand in auctions indicates that supply-demand imbalances persist, further reinforcing upward pressure on yields.

30-Year Yield Approaching 6%. Ian Lyngen, head of rates at BMO Capital Markets, previously stated that if the 30-year yield remains above 5.25%, it will trigger a "more lasting correction" in stock valuations. The current 30-year yield is at 5.2%. The consensus forecast target from Bank of America is 6%. The critical point for structural valuation reassessment in the stock market is approaching.

Framework for Asset Allocation in Response to Current Environment:

Stock Investors: Consider a moderate rotation from long-duration growth stocks to value stocks, financial stocks, and sectors with stable current earnings.

Bond Investors: Prefer medium-term bonds and high-quality investment-grade credit bonds over long-term Treasuries.

Income Investors: Current yield levels represent a rare opportunity to lock in quality income over the past decade.

The equity risk premium is close to zero. The 30-year yield has reached its highest level since 2007. The new Federal Reserve Chairman is taking on the inflation challenge. Bond vigilantes are making a comeback. The message from the bond market is crystal clear: the era of cheap government borrowing has ended. Whether the stock market can smoothly digest this reality or if some link will ultimately break will be the core issue facing the market in the second half of 2026.

The above investment views are sourced from BIT invited analysts and do not represent the official position of BIT.

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Data Sources

CNBC, "30-Year Treasury Yield Surpasses 5.19%, Highest Level Since Pre-Financial Crisis," May 19, 2026. CNN Business, "30-Year U.S. Treasury Yield Rises to Highest Since 2007," May 19, 2026. Federal Reserve FRED Database, 10-Year Treasury Fixed Maturity Yield, May 18, 2026. TheStreet, Market Daily, May 19 and May 15, 2026. CNBC, "Kevin Warsh Confirmed as New Federal Reserve Chairman," May 13, 2026. Yahoo Finance, "Warsh Confirmed as New Federal Reserve Chairman Amid Rising Inflation," May 2026. JPMorgan Global Research, "Next Steps for the Federal Reserve," April 2026. Fortune Magazine, "The Bond Market is Shouting," May 2026. HeyGotrade, "10-Year Treasury Hits 4.6%: How Rising Yields Reshape the 2026 Stock Market," May 2026. Mercer Media, "30-Year Treasury Yield Surpasses 5.1%," May 2026. Allianz Global Investors, Moody's Downgrade Analysis, 2025. Fidelity Investments, U.S. Credit Rating Downgrade, May 2025. Wikipedia, "One Big Beautiful Bill" entry. Price, "Impact of U.S. Tax Legislation on the Economy and Bond Market," July 2025. Bank of America Asset Management, "Impact of Interest Rate Changes on the Bond Market," April 2026.

Data as of May 19, 2026.

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