The benchmark U.S. 10-year Treasury yield climbed to its highest level since 2007 on Tuesday, extending a sell-off in government bonds as investors confronted the prospect of higher-for-longer interest rates and a worsening oil supply shock ahead of the Federal Reserve’s latest policy decision.
The 10-year yield rose 8 basis points to 5.041% as of 4:07 a.m. ET, after briefly breaking above 5% on Monday before retreating. The move puts the benchmark yield at a level not seen since before the global financial crisis and signals how quickly inflation and interest-rate expectations can overwhelm demand for U.S. government debt.
The 30-year Treasury yield, which is particularly sensitive to long-term inflation and geopolitical risks, climbed 7 basis points to 5.4%. The two-year yield, which more closely tracks expectations for Fed policy, rose about 5 basis points to 4.686%.
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Bond prices move inversely to yields, meaning the rise represents a broad decline in the value of existing Treasurys.
The sell-off comes as the Federal Reserve begins a two-day policy meeting, with markets assigning more than a 92% probability to a 25-basis-point rate increase, according to the CME FedWatch tool. August inflation remained well above the central bank’s 2% target, leaving policymakers with less room to ease financial conditions even as economic risks build.
That tension is gaining attention because the latest threat to inflation is coming from oil.
“U.S. 10-year treasuries are highly sensitive to inflation expectations, and with inflation gauges still above the Fed’s target of 2%, we believe this tight correlation will likely persist for a while,” said Jonathan Liang, Standard Chartered’s chief investment officer of fixed income and foreign exchange.
The relationship between crude prices and Treasury yields has become unusually strong. The one-month rolling correlation between front-month West Texas Intermediate crude and the 10-year Treasury yield has risen to 0.96, according to BMO Capital Markets.
“Speaking simplistically, higher oil prices lead to higher inflation expectations and vice versa,” said Steve Sosnick, chief strategist at Interactive Brokers.
“Normally, the relationship isn’t as clean as it is now, but the geopolitical drivers behind the price of oil and global inflation are so prominent that the normally modest correlation has become much tighter,” he said.
“As long as oil prices remain firm and continue to drift higher, this will add pressure to interest rates,” Sosnick added.
Oil Shock Complicates the Fed’s Inflation Fight
Oil prices rose more than 2% on Tuesday after attacks on Saudi Arabian energy infrastructure disrupted the kingdom’s East-West pipeline, intensifying concerns about the availability of crude and the duration of the disruption.
Brent crude futures rose $2.50, or 2.37%, to $108.18 a barrel at 8:13 a.m. GMT, while U.S. West Texas Intermediate futures gained $2.46, or 2.43%, to $103.85.
The attacks have introduced another source of inflation pressure at precisely the moment when the bond market is already demanding greater compensation for holding long-term U.S. debt.
Iran-backed Houthi forces in Yemen launched fresh attacks on Saudi Arabia on Monday, while Gulf Arab states postponed planned discussions with Iran. The escalation has raised concerns that damage to energy infrastructure and transportation routes could take longer to repair.
“Fresh attacks by the Houthis targeting Saudi Arabia may be influencing oil market investors’ expectations about the severity and duration of the conflict,” said Hamad Hussain, senior climate and commodities economist at Capital Economics.
The Houthis said Monday that they had fired dozens of missiles and drones at a military airbase in Khamis Mushait in southern Saudi Arabia, targeting aircraft hangars, radar systems, runways and ammunition depots in retaliation for Saudi airstrikes in Yemen.
The attacks followed strikes on Friday that disrupted Saudi Arabia’s East-West pipeline, a crucial alternative route that allows the kingdom to transport oil to the Red Sea and bypass the Strait of Hormuz.
The pipeline is therefore more than a piece of infrastructure. Its disruption reduces Saudi Arabia’s ability to move crude without relying on a maritime chokepoint that has already become a major source of market anxiety.
The Strait of Hormuz previously carried about one-fifth of global oil supplies. Commodity vessel traffic through the strait fell to just four vessels on Monday from 10 the previous day, according to preliminary Kpler data.
Saudi Arabia could exhaust crude available for export within days if the East-West pipeline is not restored, according to buyers and traders. The disruption has threatened as much as 4% of global oil supply.
Goldman Sachs said the latest attack could be more severe and potentially threaten the remaining 2 million barrels per day of recent Yanbu exports. Repair estimates range from “very soon” to as long as eight weeks, according to the bank.
The duration of the disruption is becoming almost as important as the initial supply loss. A short-lived outage could produce a temporary price spike, while prolonged damage would force buyers to compete for a smaller pool of available crude and could feed higher energy costs into transportation, manufacturing and consumer prices.
Goldman Sachs said the attacks represented a meaningful escalation and increased the probability that Brent crude could rise above $120 a barrel. Its scenario assumes average Gulf oil production in 2027 remains 4 million barrels per day below pre-war levels.
Capital Economics’ Hussain warned that, without a demand adjustment or increased flows through the Strait of Hormuz, several weeks of East-West pipeline disruption could push Brent toward $130 a barrel.
That scenario would create a difficult environment for the Federal Reserve.
A conventional inflation shock caused by strong domestic demand can eventually be addressed through tighter monetary policy. An oil shock is different. Higher interest rates cannot produce more crude or reopen a damaged pipeline. Yet if energy prices lift headline inflation and begin feeding into broader price expectations, the Fed may still be forced to maintain or increase monetary restraint.
That helps explain why the Treasury market is reacting so sharply.
The rise in the two-year yield points to immediate concern over Fed policy, while the move in the 10- and 30-year maturities suggests investors are also demanding greater compensation for long-term inflation and fiscal risks.
A sustained oil shock could therefore produce an uncomfortable combination of higher inflation, higher Treasury yields and weaker economic growth. That would raise borrowing costs for households, companies and the U.S. government while simultaneously putting pressure on corporate valuations.
The significance of the 5% threshold in the 10-year yield extends beyond the bond market. Treasury yields serve as a reference point for mortgages, corporate borrowing, and the valuation of equities. As risk-free yields rise, investors generally require stronger earnings prospects to justify elevated stock-market valuations.
For markets already sensitive to inflation and monetary policy, another leg higher in Treasury yields could therefore broaden the pressure well beyond government bonds.
China provides a partial counterpoint to the supply concerns. Official data showed that Chinese oil throughput increased for a second consecutive month in August, supported by higher fuel exports after Beijing eased restrictions in mid-July.
But stronger Chinese refinery activity does not eliminate the broader supply risk. If disruptions persist across Gulf infrastructure and shipping routes, the market may have to absorb a prolonged reduction in available crude regardless of regional demand.
The immediate concern for investors is no longer about the Fed raising rates by 25 basis points. Markets are increasingly trying to determine how much additional inflation pressure the central bank will have to absorb if oil remains above $100 and moves toward $120 or higher.
A 5% 10-year yield was once viewed as an important psychological barrier. With the geopolitical shock now feeding directly into energy prices and inflation expectations, the more consequential issue is whether the yield can remain above that level. If it does, the Treasury market could be entering a more persistent repricing in which inflation, oil and monetary policy reinforce one another.
Analysts warn that this would make the Fed’s task harder and raise the cost of capital across the global economy at the same time.