Treasury yields hit 5% as weak auction jars markets anew

Treasury yields climbed above 5% on five-year notes Wednesday, lifting US borrowing costs to levels last seen before the financial crisis.

The five-year yield crossed that threshold for the first time since 2007, leaving only the two- and three-year coupon maturities below 5%. The 10-year yield rose almost 17 basis points to 5.13%, its highest level since 2007, while the 30-year traded near 5.4%, within about 4 basis points of its highest level since 2004.

$70 billion sale tests demand

The afternoon sale of $70 billion in five-year notes cleared at a 5.033% yield, the highest auction yield for that tenor since 2006. The result was more than 3 basis points above the level expected before the bidding deadline, a gap that pointed to weaker-than-anticipated demand.

By that measure, it was the second-worst five-year auction in records dating to 2018, behind only the June 2022 sale that followed the Federal Reserve’s first 75 basis point increase of that cycle. The five-year yield rose as much as 20 basis points Wednesday and exceeded the 4.99% high reached in 2023, when the Fed was trying to bring down inflation through higher rates.

Bond prices move inversely to yields, so the rise marked a repricing of Treasury holdings across much of the curve. The move also reached equities, with the S&P 500 falling almost 1% at one point during the session.

Oil and data shift Fed bets

The early pressure followed a rise in oil prices as the standoff in the Middle East kept energy markets in focus. Releases showing US manufacturing and services activity above forecasts added to the move, giving traders another reason to price in a more restrictive policy path.

Swaps now fully reflect three 25 basis point Fed increases over the next year, with hedging also showing demand for protection against a fourth move. If those increases occur, the target range would rise to 4.75% to 5%, compared with the current 3.75% to 4% range set last week after the first increase in three years.

Chairman Kevin Warsh said last week’s move removed a "dose of accommodation." Policymakers are still facing inflation that has not returned to the Fed’s 2% target in five and a half years, while the labor market remains firm and some officials have warned that elevated energy prices could keep price pressures persistent.

"Pressure is starting to build up on the short end of the yield curve," said Christophe Boucher, CIO of ABN AMRO Investment Solutions. He said Wednesday’s data would allow the Fed to "double down" on its hawkish stance.

Treasury buybacks face higher yields

The selloff raises the test for the Treasury Department’s expanded buyback program, which was announced in mid-August after long-term yields had already climbed to multiyear highs. The second operation under the expansion, aimed at debt maturing in 20 to 30 years, is scheduled for Thursday.

The buyback target is $6 billion, matching the first expanded operation on September 10 and exceeding earlier guidance that the amount would at least double to $4 billion. Long-end yields kept rising after the target was announced, showing that buybacks have not yet offset the market’s concern about supply, inflation and Fed policy.

If oil prices stay elevated and economic releases keep beating forecasts, the macro effect would be tighter financial conditions through higher borrowing costs and lower bond prices. For the Treasury Department, auction demand would become the immediate constraint; for banks, mortgage lenders and fixed-income managers, higher benchmarks would feed into loan pricing, portfolio losses and duration risk.

If demand improves at coming auctions and inflation data soften, the pressure could ease through lower expected policy rates and stronger appetite for longer maturities. The main open question is whether buyers require still-higher yields to absorb new supply before Thursday’s long-dated buyback operation and the next round of Fed communication.