Oil Price Shock Blasts Treasury Yield Past 5% as Debt Spiral Threatens

The benchmark 10 year Treasury yield briefly broke above 5% on Monday for the first time since 2023, as surging oil prices threatened to spill into government debt markets.

The yield later retreated, but the breach marked a stark new stage in the market shock.

The yield has climbed more than 100 basis points since shortly before the Iran war began in late February. At that time, the 10 year rate was below 4%.

The war is now in its seventh month, with little evidence of diplomatic progress toward fully reopening the Strait of Hormuz.

Crude oil and refined fuel products have therefore remained expensive.

Energy markets are in some respects in worse condition than they were at the height of the Iran war.

Although the U.S. military is guiding significant oil volumes through the Strait of Hormuz, tanker traffic remains well below prewar levels.

That reduced traffic means U.S. oil reserves must continue being drained. Those reserves are already at their lowest level in more than 40 years.

At the same time, Houthi rebels backed by Iran have seized control of the Bab al Mandab Strait, a vital bypass that allowed Saudi oil to avoid the Strait of Hormuz.

A drone attack has also shut Saudi Arabia’s East-West Pipeline.

The pipeline had diverted much of the kingdom’s oil from the Persian Gulf to the Red Sea. Its closure added another disruption to an already strained energy transportation system.

Brent crude prices surged as much as 4% on Monday, nearing $110 per barrel and reaching their highest level since May.

The prospect of energy costs remaining elevated indefinitely is also lifting inflation expectations.

Bond yields across Europe and Asia climbed alongside U.S. Treasury yields. The increase arrived just as the Federal Reserve was widely expected to raise interest rates on Wednesday, with other central banks likely to follow.

“After several years in which inflation has run above target, it has become harder for policymakers to 'look through' the otherwise temporary effects of higher inflation caused by supply shocks,” Neil Shearing, group chief economist at Capital Economics, said in a Monday note.

“More importantly, in a world of high public debt and large fiscal deficits, there is a potential feedback loop through the bond market that could make a difficult situation considerably worse.”

U.S. inflation has remained above the Fed’s 2% target for more than five years. Policymakers have become less willing to wait for prices to cool, while some Wall Street participants expect a total of three Fed rate increases.

Higher interest rates will eventually flow into higher bond yields, increasing the cost for governments to sustain enormous deficits and debt loads.

That pressure could deepen concerns about public finances.

“Those concerns can push bond yields higher still, creating a self-reinforcing cycle in which rising yields feed fiscal worries, which in turn drive yields higher,” Shearing explained.

The U.S. is not yet experiencing a self fulfilling fiscal crisis because nominal gross domestic product growth continues to outpace debt servicing costs, Shearing added.

Even if the oil shock proves manageable, he warned that heavily indebted economies are more vulnerable to supply shocks intensified through bond markets.

“In fact, there is a good case to be made that the key risk from a global macro perspective is less the initial shock than the feedback loop it could set in motion,” Shearing wrote.

The 5% threshold could also weigh on technology stocks, which sold off Monday as chipmakers led the decline. Those companies had benefited from the enormous wave of spending by hyperscalers.

Rockefeller International Chairman Ruchir Sharma warned in a Financial Times opinion article that the AI bubble could burst when the 10 year yield “decisively breaches” 5%.

That level has represented the upper end of its range since the dotcom era.

Sharma said borrowing costs at that level could prompt hyperscalers to issue fewer bonds to finance spending.

Companies could also face greater difficulty issuing new equity because yields above 5% have historically created a headwind for stocks.

Yields above 5% would also begin approaching nominal gross domestic product growth, making the national debt still more unsustainable, Sharma said.

Although others on Wall Street view yields as normalizing after years of central bank suppression, he noted that the U.S. debt burden now exceeds 100% of gross domestic product.

“As a result, debt-servicing costs are much higher now,” Sharma wrote. “Rising public borrowing costs will squeeze other borrowers sooner, and hit the bubbly AI markets harder.”