Understanding the "Black Wednesday" of U.S. Treasuries in one article: The impact of the "perfect storm" and the winds of "October rate hike" rising

Author: Dong Jing
Multiple negative factors concentrated on the same day triggered a severe sell-off in the U.S. Treasury market, experiencing the worst single-day drop in nearly 18 months.

The yield on the 10-year U.S. Treasury surged about 14 basis points on Wednesday, closing at 5.113%, a new high since 2007, marking the largest single-day increase since the so-called "reciprocal tariff day" impact last April under Trump. Market participants described this trend as a "perfect storm"—strong PMI data, escalating tensions in the Middle East, hawkish statements from Federal Reserve officials, and weak Treasury auction results all struck on the same trading day.

The core signal of this impact is: the market's bets on another rate hike by the Federal Reserve in October have sharply increased. Current futures market pricing shows that the probability of a rate hike by the end of October has risen to 68%, just days before the U.S. midterm elections. Meanwhile, the swap market has fully absorbed expectations for three 25 basis point hikes within the next year, with significant hedging for a fourth hike. If all materializes, the target range for the federal funds rate will rise to 4.75% to 5%.

At the same time, the continuous rise in yields is transmitting to the real economy. The 30-year mortgage rate has surpassed 7%, putting increasing pressure on sectors reliant on debt financing, such as private equity. The Treasury Secretary's bond buyback plan has failed to effectively curb the selling momentum, and market confidence is clearly lacking.

The stock market also fell, but the declines were relatively moderate—the S&P 500 index closed down about 0.8%, the Nasdaq Composite dropped 1.1%, and the Dow Jones Industrial Average fell about 352 points.

Fourfold Impact Strikes, "Perfect Storm" Forms

Wednesday's bond market collapse was not due to a single event but rather the result of multiple negative factors resonating on the same trading day.

First Strike: Oil Prices Surge, Middle East Diplomatic Hopes Fade. In the morning session, international oil prices surged during European trading hours. Previously, the market hoped that the United Nations General Assembly taking place in New York could ease U.S.-Iran relations, but Iranian President Masoud Pezeshkian's statements dashed those expectations—he stated that Iran is willing to negotiate but will not accept Trump's "bullying," warning that as long as sanctions continue, Iran will not fully open the Strait of Hormuz. The international oil price benchmark, Brent crude, closed up nearly 4% that day. The ongoing rise in oil prices could transmit to broader inflation, as bond yields have been highly correlated with oil price movements in recent months.

Second Strike: PMI Data Surges, Economic Overheating Concerns Intensify. S&P Global released the preliminary report for the U.S. Composite PMI for September, showing that U.S. business activity expanded at the fastest pace in over five years, with job growth at its highest in over four years.

S&P Global Chief Business Economist Chris Williamson stated, "Aside from the demand rebound following the end of COVID-19 lockdowns, this improvement in business activity is the largest since early 2015." Following the data release, both short-term and long-term Treasury yields jumped.

Third Strike: Hawkish Statements from Federal Reserve Officials. Federal Reserve Governor Michael Barr spoke in Chicago, clearly stating that "inflation is above the 2% target, and there is no clear trend toward the target," and noted that "in my baseline scenario, further policy adjustments may be needed to ensure inflation returns to target in a timely manner." HSBC U.S. interest rate strategist Dhiraj Narula pointed out that the market is concerned that "the Federal Reserve is willing to continue raising rates despite the pressures from supply shocks, indicating that the hawkish stance may remain unyielding."

Fourth Strike: Disappointing 5-Year Treasury Auction Accelerates Panic. The U.S. Treasury's $70 billion 5-year Treasury auction faced a lackluster response. The winning yield was 5.033%, about 3 basis points higher than the market trading level before the auction—this premium is quite significant in this typically large market that can smoothly absorb supply. Underwriters (primary dealers) were forced to take on an unusually large proportion of the bonds, the highest since 2024, indicating a lack of interest from other potential buyers. Following the auction results, yields rose further, and panic spread.

Yields Break Key Levels Across the Board, Hitting Multi-Year Highs

The intensity of this sell-off is evident in the data.

The yield on the 10-year U.S. Treasury closed at 5.113%, marking the first time it has surpassed 5% since 2007, with a single-day increase of about 14 basis points, the largest single-day increase since the so-called "reciprocal tariff day" impact last April, constituting an extreme fluctuation of about 4 standard deviations—just two weeks ago, the market had experienced a 3 standard deviation shock, putting pressure on the VaR (Value at Risk) of various risk books.

The 5-year yield surged nearly 20 basis points in a single day, breaking above 5% for the first time since 2007, with the auction failure further accelerating this trend.

The 30-year yield rose to its highest level since 2004. The 2-year yield briefly reached its highest since 2024 before slightly retreating to 4.90%, up 12 basis points from the previous day.

Bond volatility indicators also surged significantly, indicating a severe lack of confidence in the market regarding future trends. Sean Simko, head of fixed income investment management at SEI Investments, summarized the day's situation as a "triple blow":

"Stronger economic data, supply pressures pushing the 5-year yield to levels not seen in years, and the judgment of global inflation stickiness."

The Essence of the Sell-off: Real Rate Repricing, Not Just Inflation Panic

It is noteworthy that the driving logic behind this bond market sell-off is not simply an increase in inflation expectations.

According to Bloomberg analysis, about 80% to 85% of the sell-off's magnitude comes from rising real rates: the nominal 10-year yield rose about 15 basis points, the yield on 10-year Treasury Inflation-Protected Securities (TIPS) increased by about 12.5 basis points, while the breakeven inflation rate only rose by about 2 basis points.

This means that bond investors are repricing for a combination of factors: a Federal Reserve path of maintaining high rates for a longer time, stronger real growth expectations, a higher neutral rate, a higher real term premium or duration compensation, as well as greater supply pressures and tighter global financial conditions.

Goldman Sachs' Rich Privorotsky tends to interpret this trend from a growth perspective:

"To me, this increasingly looks like a reflection of the strong growth assumption (6% fiscal deficit plus $1.5 trillion in spending means a lot of bond supply and a lot of nominal growth). This poses a clearer macro risk for the stock market—not out-of-control inflation, but persistently high real capital costs."

The Atlanta Fed's GDPNow model predicts that the U.S. economy will grow at an annualized rate of 5.1% in the third quarter, which, if realized, would be the fastest growth since the post-COVID recovery. JPMorgan Chase economists noted after last week's Federal Reserve meeting that Fed officials "may be seeing an increase in the risk of demand-driven overheating, and policy may need to respond to this."

BNY Chief Investment Officer and Head of Credit Services Jason Granet raised a key question: "The Federal Reserve has already begun raising rates. The question now is… will it stay on this path for a considerable time?"

Buyback Plan's Effectiveness in Doubt, Treasury Under Pressure

In the face of rising yields, Treasury Secretary Yellen has attempted to suppress yields by expanding the scale of long-term Treasury buybacks, but the effect has been limited.

On Wednesday, the Treasury announced it would buy back up to $6 billion of 20- to 30-year Treasuries on Thursday, marking the second operation since the expansion of the buyback plan announced in mid-August. However, this scale disappointed the market. JPMorgan Asset Management Chief Investment Officer Bob Michele bluntly stated:

"We thought the Treasury would see that the last $6 billion buyback was a failure and would aim for close to $10 billion this time. But they didn't."

After the announcement, the yields on 20-year and 30-year Treasuries rose further, and bond volatility indicators surged, indicating a severe lack of confidence in the buyback plan.

Christopher Sullivan, Chief Investment Officer of United Nations Federal Credit Union, summarized the current predicament of the bond market: "From the unresolved conflict in Iran to the seemingly unbreakable U.S. economy, holding bonds now 'doesn't make sense' for many people."

Stock Market Relatively Resilient, But Interest Rate Risks Cannot Be Ignored

Despite the severe blow to the bond market, the decline in U.S. stocks has been relatively limited. Scott Kimball, Chief Investment Officer of Fixed Income at Loop Capital Asset Management, stated, "Risk markets are handling this quite well. It really seems to be an interest rate market issue."

However, the continuous rise in yields has triggered a chain reaction in the real economy—from mortgage rates and credit card rates to the willingness of private equity firms to engage in leveraged buyouts, all have been affected. The 30-year mortgage rate has surpassed 7%, directly pressuring the real estate market.

Christophe Boucher, Chief Investment Officer at ABN AMRO Investment Solutions, warned, "The short-end yield curve is building pressure," and today's economic data will allow the Federal Reserve to "double down on" its hawkish stance.

RBC Capital Markets strategist Brook admitted that the market has fallen into a frustrating cycle:

"You can look at these yield levels and say, this is really attractive. But we've been playing this game for the past six months, and every time we try to draw a line somewhere, it just keeps breaking through."