CMSC: Outlook on the Trend of U.S. Treasury Yields and Their Impact

CMSC released a research report stating that U.S. Treasury yields have continued to rise recently, breaking through 4.7%. The expansion of term premiums has dominated this round of trends, reflecting the dual pressures of imbalance in the supply and demand for U.S. long-term debt and an elevated fiscal risk premium. The Treasury's expansion of long-term debt repurchase operations sends a stabilizing signal, which is beneficial for improving local liquidity of long-term debt, but the substantial impact on scale is relatively limited and difficult to resolve the mid-to-long term contradictions faced by U.S. Treasuries. In the short term, attention should be focused on this week's global central bank annual meeting, where whether Walsh's speech can restore the market's confidence in Federal Reserve policies is key. In the current phase where U.S. Treasury yield risks have yet to be resolved, gold may exhibit fluctuations at a high level, serving as an important asset for hedging against portfolio risks; the stock market can achieve balanced allocation through a combination of dividends and small-cap growth. Reasons for the rise in U.S. Treasury yields: The recent rapid increase in U.S. Treasury yields is mainly contributed by term premiums, which reflect the dual disturbances of liquidity changes in the supply and demand of U.S. long-term bonds and the fiscal risk premium. On the supply side, the U.S. Treasury maintains stable quarterly auction sizes for mid-to-long-term bonds, with limited marginal increases in supply; however, on the demand side, investors' net purchases of U.S. long-term bonds continue to decline, as confidence in U.S. fiscal and monetary policy remains weak, coupled with the crowding-out effect of major AI companies issuing bonds for financing. Since 2026, the total issuance of long-term bonds by leading CSP companies has already surpassed that of previous years by multiples. The impact of U.S. Treasury policies on bond yields: In mid-August 2026, the pressure of selling long-term U.S. Treasury bonds continued to increase, with the yield on the 10-year Treasury bond briefly exceeding 4.7%, significantly raising market concerns about liquidity risks. In response to the soaring long-term rates, on the local date of the 19th, the U.S. Treasury announced an increase in the scale of its liquidity support repurchase operations for long-term Treasuries, raising the size of each operation at least to $4 billion from the previous $2 billion, primarily involving 10-20 year and 20-30 year bonds. This measure will last until November 4. The initial announcement from Beeson effectively eased concerns and timely halted the further spread of liquidity risks. After the news was released, long-term yields quickly fell, with the yield on the 10-year Treasury declining to around 4.65%, and spot gold spiking more than $113 to $4,446 per ounce, with U.S. stock futures also rising while the dollar index fell. However, over time, the effectiveness of the policy has clearly weakened, and U.S. Treasury yields rebounded. On the 20th, Beeson further indicated that the Treasury's single long-term bond repurchase size might exceed $4 billion and emphasized that the Treasury has a strong toolbox, suggesting that policy could be further strengthened if necessary, but the market seemed unconvinced, as Treasury yields rose further on Thursday and Friday, finishing at over 4.7%, closing at 4.732%. How to understand the U.S. Treasury's policy of expanding the long-term bond repurchase scale? First, the U.S. Treasury's expansion of the long-term bond repurchase scale is somewhat similar to the previous Fed's Operation Twist, which does not bring incremental liquidity but will improve the liquidity of long-term bonds locally. This differs fundamentally from the Fed's quantitative easing (QE) and the Bank of Japan's yield curve control (YCC). The funding for the Treasury's repurchases mainly comes from financing via short-term debt, and the issuance structure of U.S. Treasuries shows that the proportion of short-term bond issuances has continued to rise. This means that the marginal supply of new financing is concentrated on the short end, and the policy effectively resembles the Fed's Operation Twist, providing support for long-term bond demand without additional liquidity supply, only shortening the weighted duration of circulating Treasuries. However, in terms of scale, a monthly repurchase scale of $4 billion (20-year and 30-year bonds) is relatively low compared to the current average monthly issuance scale of $37 billion (with 20-year bonds at $14 billion and 30-year bonds at $23 billion), so the substantial impact of this scale is limited, and it serves more to release a policy signal to prevent a further escalation of panic. Second, the policy of expanding bond repurchase scales can alleviate local liquidity but cannot address mid-to-long term contradictions such as high inflation, the crowding-out effect of AI bonds, and concerns about U.S. debt sustainability, which explains why U.S. Treasury yields only fell for one day after the policy announcement before rising again. The situation in the Middle East causing oil prices to fluctuate repeatedly has been affecting global inflation concerns. The persistent geopolitical conflict in the Middle East continues to disrupt the global energy supply chain and raise the central price of international oil; rising oil prices have repeatedly affected inflation, delaying the pace at which U.S. inflation falls. Currently, the progress in U.S.-Iran negotiations is slow, remaining deadlocked over the agreement issue, with threats coming from both sides. In this situation, the Federal Reserve is likely unable to quickly turn to easing, and long-term Treasuries will need to account for higher inflation compensation. Future monitoring is needed on whether navigation through the Strait of Hormuz can remain stable, as well as whether energy supply and inventory conditions can gradually improve. If substantial progress is made in this situation, declining geopolitical premiums and market expectations for U.S. inflation improvement leading to Federal Reserve policy easing will rise. Currently, the market retains over 70% probability of a Fed interest rate hike within the year, with September hike expectations exceeding 40%. The bond issuance demand driven by AI capital expansion will continue to crowd out long-term U.S. Treasuries. The large-scale capital expenditure of major U.S. AI firms maintains high growth, translating into significant long-term financing demand, continuing to create a crowding-out effect on long-term Treasuries. During this current AI expansion cycle, leading AI tech companies in the U.S. are continuously increasing capital expenditure and issuing bonds. Formerly a source of market funding, tech giants have now shifted to becoming demanders of funds. Under the stable total amounts of long-term allocated funds such as insurance and pensions, their diversion of market funds crowds out demand for Treasury bonds, raising long-term Treasury yields and term premiums. Whether this pressure can be relieved going forward largely depends on the speed at which AI investments convert into stable income and free cash flow. If relevant companies achieve sustained revenue growth and improve cash flow coverage for capital expenditures, their debt financing needs and the resultant duration supply are expected to gradually decline; however, during a phase where earnings are not yet realized, AI investments may continue to present structural disturbances to long-term rates. Meanwhile, the continuously expanding scale of financing has significantly increased the sensitivity of AI tech stocks to long-term rates. Recently, the rise in CDS spreads has signaled market concerns over AI firms' bond financing. Leading U.S. cloud companies are intensifying their investment in AI infrastructure and rapidly expanding capital expenditure; recent earnings reports show that Google, Amazon, and other cloud firms have turned free cash flow negative, causing the financing demand to shift from internal funds to debt financing. Recent increases in CDS spreads reflect rising market concerns regarding the AI investment payback period, pressure on balance sheets, and debt sustainability. Specifically, Nvidia's five-year bond CDS spreads have hit record highs, while Google's five-year CDS, known for its stability, is also nearing previous highs. The repricing of credit risk will elevate bond issuance costs and tighten financing conditions, subsequently impacting the capital expenditure capabilities of cloud firms, causing a chain reaction in the AI sector. Concerns over high deficits and debt sustainability in the U.S. pose mid-to-long term constraints on U.S. Treasuries. The risk of debt sustainability does not imply that the U.S. will default in the short term; rather, the more pressing issue is that high interest rates and high deficits are reinforcing each other. This concern may repeatedly disturb the market during periods of pessimism toward U.S. Treasuries. Rising rates increase government interest expenditure, which in turn expands fiscal deficits, necessitating the issuance of more Treasury bonds for financing; following increased bond supply, investors demand higher term compensation, further exacerbating interest burdens. As of June 2026, the ratio of U.S. government rolling 12-month interest expenditure to fiscal revenue has reached 22.74%. Adjustments to issuance tenure or expanding the repurchase of old bonds can only improve local liquidity and will not significantly reduce overall financing needs. Recently, the Treasury has raised the net market financing requirement for the third quarter of 2026 to $739 billion. This is precisely why U.S. Treasury yields have risen recently while the dollar index has fallen. From the perspective of the dollar SOFR-IORB spread, the local liquidity shortages and risk aversion of U.S. Treasuries have not triggered a liquidity squeeze in the dollar. What this reflects is that after Beeson announced the expansion of repurchase scales, market concerns over U.S. fiscal deficits and expanded financing have not diminished, reinforcing the logic of U.S. credit detriment, leading to a weaker dollar. 3. How does the rise in U.S. Treasury yields impact the market? (1) Gold The persistent deterioration of dollar credit and the resulting reconstruction of global reserve assets represent the core driving force and underlying logic for rising gold prices. In the short term, changes in liquidity (fluctuations in real U.S. Treasury yields) have a more direct impact on the timing. Since August, gold's rebound has mainly benefited from the cooling expectations of Federal Reserve rate hikes and fund replenishment. Recently, gold has continued to rise, partly driven by the decline in U.S. Treasury yields following Beesons announcement to expand repurchase operations on August 19. Additionally, despite U.S. Treasury yields returning to an upward trend on Friday, gold has been rising in opposition to this, primarily pricing in damage to dollar credit. Consequently, in the short term, gold pricing will oscillate between real U.S. Treasury yields (liquidity) and mid-to-long term narratives (deterioration of dollar credit). Given the substantial previous rebound in gold, it is anticipated that in the near future it may exhibit high levels of volatility. In the current phase, where the risk associated with U.S. Treasury yields has yet to be resolved, it serves as an important asset for hedging portfolio risks. (2) A-shares The stock market recovery driven by the resonance of macro and micro liquidity improvements since August has come to an end, with rising yields and geopolitical risks intermingling alongside the approaching concentrated disclosure window for mid-year earnings, leading to increased market volatility and phased pressure. Investors are expected to focus more on structural opportunities along the performance line, with style rotation becoming more balanced; a combination of dividends and small-cap growth can be used for balanced allocation. In terms of sectors, it is recommended to pursue a three-line balanced layout along the axes of technological innovation, companies going overseas, and traditional undervalued stocks, with a focus on electronics, chemical pharmaceuticals, non-ferrous metals, and coal. Based on historical experience, once U.S. Treasury yields peak and then decline, the growth direction typically shows a higher probability of increase and a larger magnitude within the following month. Specifically, since 2023, in the last four occasions when U.S. Treasury yields topped and declined, indices such as the CSI 2000, ChiNext index, and CSI 1000 have shown significantly leading average gains, with an increase probability of 100%. In addition, TMTs average gains have been the highest. 4. Future trends of U.S. Treasury yields and short-term attention points In summary, the recent rise in U.S. Treasury yields is mainly contributed by term premiums, reflecting changes in the liquidity of the supply-demand relationship for U.S. long-term bonds and a fiscal risk premium. The U.S. Treasury's expansion of long-term bond repurchase operations has released positive policy signals that help to locally alleviate the liquidity pressure on long-term bonds and mitigate the shocks from high long-term bond rates. However, the crowding-out effect of large-scale AI bond issuance on U.S. long-term bonds persists, and from a mid-to-long term perspective, only by reducing fiscal deficits, controlling the growth rate of debt, and stabilizing inflation expectations can we truly change the supply-demand relationship and risk pricing of long-term Treasuries. In the short term, the market will likely wait for more signals from this week's Jackson Hole global central bank meeting, where whether the market can regain confidence in Federal Reserve policies will be crucial. This will depend on whether Walsh's speech can deliver clearer policy signals (credible policy reaction functions) to the market. Observations should be made on how the 2-year Treasuries, 30-year Treasuries, the dollar, and gold markets respond following the speech. The 2-year yields mainly reflect market judgments of the Feds short-term policies, while the 30-year yields more reflect real long-term rates, inflation, and fiscal credit risks. The dollar and gold combination can help assess whether the market is trading normal interest rate changes or the U.S. monetary credit. Before that, it is expected that long-term U.S. Treasury yields will continue to exhibit high-volatility levels. If long-term bond yields continue to rise, this may compel the U.S. Treasury to adopt stronger stabilization policies. The government has sufficient policy tools to address liquidity issues, and while mid-to-long term contradictions still exist, U.S. Treasury yields may indeed retreat from high levels, potentially providing better allocation opportunities for the market.