The market has spoken—and it’s not impressed. The so-called “Big, Beautiful Bill” may be substantial in size, but bond investors are signaling it’s anything but beautiful for U.S. fiscal credibility as pressure is intensifying on long-end Treasury yields. While we witnessed a strong 2-year note auction on Tuesday (largely a byproduct of Japan’s bond market crisis, which prompted the Ministry of Finance to send a trial balloon on the possibility of reducing supply at the long end to calm the markets), weaker-than-expected auction results (disastrous 20-year auction) have only fanned the flames, giving bond markets fresh reason to push interest rates higher. Even if we get a benign PCE deflator on Friday, it will likely do little to dispel a bearish tilt in long-end US Treasuries.
The 10-year Treasury yield jumped to 4.62%, while the 30-year surged to 5.14% since our last column, reflecting both rising skepticism and growing financing costs for America’s ballooning debt. Note: It’s not so much the level but the speed of these moves that makes markets nervous. Perhaps most telling was the steepening of the 5s/30s Treasury yield spread, which reached 1.00%—a level not seen since October 2021—before pulling back early this week. This shift signals expectations of stronger economic growth, stickier inflation, and a “higher-for-longer” policy stance from the Federal Reserve. Notably, the last time this spread was at similar levels, CPI inflation was running at 6.2%.
Another red flag is the divergence between rising U.S. Treasury yields and a strengthening USD/JPY exchange rate. Despite higher Japanese yields, the yen’s move points to waning demand for Treasuries from Japanese investors, who are now finding more attractive yields at home—further eroding a key pillar of U.S. external financing.
Bond Market Mayhem
The bond vigilantes—long dormant—appear to be reawakening. Recent Treasury auctions are flashing warning signs across the curve. Last week’s $16 billion 20-year auction was among the worst since the tenor’s inception five years ago. The auction priced at a high yield of 5.047%, trailing the When-Issued by 1.2 basis points, a poor showing compared to the six-auction average of 0.4 basis points.
While dealer participation and direct demand were not catastrophic, the soft bid-to-cover ratio and a “chunky tail” reveal tepid appetite—especially troubling in the wake of the credit downgrade. The auction’s poor showing helped push 30-year yields above 5%, marking their highest level since October 2023, and sent swap spreads tumbling, a potential warning for bond market liquidity and stability.
Yield Curve Signals Growing Concern
The 2s30s yield curve has steepened to 107 basis points, its highest level since the late-April selloff. Meanwhile, the 3-month/10-year spread is at its steepest since mid-February, reinforcing the message: the front end remains anchored by rate cut expectations, while the long end is under siege from fiscal stress.
Widening U.S. Treasury yields relative to SOFR swaps and especially to German Bunds (where the U.S./Germany 10-year spread has widened nine basis points to 184 basis points) underscores the domestic nature of the market’s concerns. The bond market is no longer pricing U.S. Treasuries as a haven, but as a risk asset in need of a fiscal backstop.
What Comes Next?
At the heart of the problem: foreign investors are showing a reduced willingness to finance the U.S. twin deficits—trade and fiscal—at current yield levels. The implications are profound and structural.
There are two potential paths forward: Credible fiscal tightening – A significant revision of the current tax and spending proposals to rein in deficits and restore bond market confidence. Dollar devaluation – A potential weakening of the U.S. dollar to make Treasuries more attractive to foreign investors, particularly those in Japan, who have historically stepped in during global “risk-off” periods.
Until then, the headwinds facing U.S. Treasuries are unlikely to abate. Market signals are growing louder, and policymakers may soon be forced to choose between fiscal credibility and financial market stability. The bond vigilantes are watching—and this time it appears they’re not bluffing.
While the technical backdrop is conducive for a period of retrenchment in yields (deeply oversold levels, RSI at extremes, sentiment overly bearish), it appears it will be a tough slog to get back below 4.25%.
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