U.S. Treasuries "Force the Hand" of Warsh: Hawkish Comments Are Not Enough, Market Demands Rate Hikes

The U.S. Treasury market is sending a clear signal to Federal Reserve Chair Warsh: tough talk on fighting inflation is far from sufficient to soothe investors.

The new round of military conflict between the U.S. and Iran that erupted in July caught Wall Street off guard. International oil prices briefly breached $100 per barrel, triggering another wave of massive selling in the $30 trillion U.S. Treasury market. The benchmark 10-Year Treasury Yield has risen by more than 30 basis points since late June, hovering near 4.678%, approaching its highest level in nearly a decade. Meanwhile, the yield on the 2-year Treasury note, which is most sensitive to monetary policy, has also climbed to approximately 4.328%, breaking through the Federal Reserve's current interest rate ceiling of 3.75%. This reflects the market's strong expectations for future rate hikes.

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

"This illustrates how concerned the market is about inflation, and also how worried it is about whether the Federal Reserve can match its words with actions," said Gennadiy Goldberg, Head of U.S. Interest Rate Strategy at TD Securities, referring specifically to Warsh's series of public statements on bringing inflation back to the 2% target.

Oil Price Shock Combined with Bond Market Pressure Pushes U.S. Treasury Yields Near Decade Highs

The U.S.-Iran conflict was the direct trigger for this round of rising U.S. Treasury yields. Soaring oil prices exacerbated market fears of a resurgence in inflation, prompting traders to sell off U.S. Treasuries heavily. According to GasBuddy data, U.S. retail prices for regular gasoline and diesel have recently returned to above $4 and $5.20 per gallon, respectively.

After Warsh held his first press conference as Federal Reserve Chair in June, the Treasury market experienced a brief rebound, but this gain quickly evaporated. The yield on the 30-year Treasury note stubbornly remained above 5%, causing heavy losses for investors who had previously 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 in the U.S.-Iran war, which is a complicating factor for any duration assets at present." He also pointed out that the continued expansion of corporate bond issuance by technology-related companies is putting pressure on the Treasury market. Rosenberg stated that he has adjusted his portfolio, shifting his long positions in 30-year Treasuries, which had underperformed, to short-duration U.S. Treasuries.

Paul Christopher, Head of Global Investment Strategy at Wells Fargo Investment Institute, said: "The Federal Reserve needs to hear this signal clearly. Uncertainty is accumulating," and bond market investors are demanding corresponding compensation.

Debate Over the Rate Hike Window: The Cost and Timing Dilemma of Policy Action

The Federal Reserve is not monolithic. It is reported that some members of the interest rate decision-making committee favor raising interest rates to curb inflation. However, the issue lies in the fact that the timing of any rate hike implementation is extremely sensitive.

Inflation itself erodes the real value of fixed-income assets, while rate hikes further depress bond prices and drag down other financial assets such as stocks. At the same time, Barclays analysts expect the U.S. fiscal deficit in 2026 to be around $2 trillion. The continuous large-scale issuance of Dollar Bonds will be an important way to fill this gap, meaning that supply pressure in the bond market will be difficult to alleviate in the short term.

Furthermore, large-scale borrowing by the technology sector is amplifying pressure on the bond market. Large technology companies, represented by "hyperscale cloud providers," are racing to issue corporate bonds to support artificial intelligence infrastructure construction, pushing up overall market borrowing costs. In a report last Wednesday, Moody's Ratings projected that capital expenditures for these hyperscale cloud providers would approach $1 trillion in 2027, surging further after nearing $800 billion this year, and warned that "soaring capital expenditures, rising leverage, and off-balance-sheet commitments" would threaten the credit quality of this group.

Stock Market Suffers Another Heavy Blow, Led by Tech Declines

The shadow of high interest rate expectations also looms over the stock market. Last week, semiconductor stocks led the declines, with the Philadelphia Semiconductor Index dropping more than 4% for the week. The Dow Jones Industrial Average fell 0.4% for the week, the S&P 500 Index dropped 0.6%, and the Nasdaq Composite Index plummeted by as much as 2.1%. The closing price of the Nasdaq Index has fallen 7.8% from the historical high set in early June.

Higher interest rate levels often suppress corporate and consumer spending, thereby dragging down economic growth and eroding corporate earnings expectations. Wells Fargo's Christopher suggested that investors might wait for this round of tech stock rotation to conclude, at which point "there may be a better entry opportunity," and hinted that "holding a certain cash reserve might not be a bad idea."