On the eve of the 5% threshold, the U.S. Treasury selloff storm poses a dilemma for the market and the Federal Reserve.

Title context: On the eve of the 5% threshold, the U.S. Treasury selloff storm poses a dilemma for the market and the Federal Reserve. Text: The bond selloff has pushed a key U.S. Treasury yield to near the 5% level, intensifying concerns from Wall Street to Washington that rising borrowing costs will hit the U.S. economy. After a surge in oil prices threatened a fresh inflation shock and the Trump administration's efforts to ease pressure in the government debt market failed to gain traction, the benchmark 10-year Treasury yield jumped to 4.97% late last week. That is just a step away from the October 2023 high, when the yield briefly topped 5% in a single trading session before retreating as buyers stepped in. The recent selloff has heightened the risks facing Federal Reserve Chairman Warsh ahead of Wednesday's policy meeting local time. On Friday, the market only stabilized after data showed consumer prices rose more than expected last month, reinforcing speculation that policymakers will begin raising rates to curb inflation that has exceeded the target for five consecutive years. "The Fed has clearly fallen behind the curve," said Tracy Chen, a portfolio manager at Brandywine Global Asset Management. "Over the medium term, yields will continue to move higher." She said this is because some of the factors driving long-term yields highersuch as the inflationary impact of the Iran warare not within policymakers' control. "I'm not sure exactly how high it will go, but I think it will definitely break through 5%." Three forces are draining the market at the same time Global bond yields have been rising since U.S. President Trump launched a war against Iran in late February, disrupting oil and gas supplies in the Middle East. In the U.S., the artificial intelligence (AI) boomwhich is both flooding the market with debt and injecting stimulus into the economyas well as concerns about the federal government's swelling deficit, have also added fuel to the fire. The rise in yields is a headache for Trump because it ripples across the entire market, driving up the cost of mortgages and other loans ahead of the November midterm elections. Earlier this month, he threatened to cut off all trade between the United States and some countries if the Fed did not cut ratesa move that would almost certainly worsen the bond selloff by stoking inflation fears. Treasury Secretary Bessent tried to curb rising bond yields by increasing the Treasury's debt buybacks, but investors responded coolly after his first such operation, and yields surged last week instead. With little prospect of an end to the Middle East conflict, investors are preparing for the risk that the bond market selloff will persist. Ian Lyngen, head of U.S. rates strategy at BMO Capital Markets, said he expects the 10-year Treasury yield to break above 5% "in a very short period of time." What exactly does 5% mean? Breaking through this level has no inherent major significancethe yield has not closed above 5% since 2007. But such round numbers are often seen as key turning points that can catalyze decisions by investors and policymakers. U.S. Treasury yields are particularly important because they serve as the benchmark for other loans. In the stock market, they are also used as a discount rate to measure the present value of expected profits in future years. The higher the yield, the smaller the present value of future earnings after discounting. Some investors say this could begin to weigh on stockswhich are still hovering near record highs thanks to strong profits from the AI boom and the economy's resilience. In addition, elevated bond yields could trigger an outflow of funds from stocks, as higher returns attract investors to bonds. "If you see bond yields rise to the 5% or 5.25% level, I think that's when the stock market will see some digestion and adjustment," said Grace Peters, head of global investment strategy at JPMorgan Private Bank. "There is a very strong psychological effect at the 5% threshold." A previous survey of 122 market participants showed that about 30% believed a 10-year yield reaching 5% to 5.25% would be enough to trigger a 10% decline in U.S. stocks from their peaka technical correction; another 22% set the trigger threshold between 5.25% and 5.5%. But notably, more than two-thirds of respondents believed the truly dangerous signal was not the absolute level of yields, but the speed at which they rise. A disorderly, rapid selloff is the biggest risk. "The inflation rate remains significantly above target, and the federal government needs to finance a massive deficit in an already heavy supply environment," said macro strategist Brendan Fagan. "If nominal economic activity remains near current levels and the Fed has implicitly accepted 3% inflation as if it were 2%, long-term interest rates will inevitably rise." Last week's turbulencewith the two-year U.S. Treasury yield posting its largest one-day gain since Trump's tariffs threw markets into chaos in April 2025has increased pressure on the Fed. That is because in recent months some of the selling has stemmed from doubts about Warsh. At his first post-meeting news conference in June, he stressed that he was focused on bringing inflation back to the central bank's 2% target. But after the July meeting, the Fed again left rates unchanged, and traders sold longer-term bonds on doubts about whether he would deliver on his pledge. On Friday, after the U.S. Labor Department reported that a core inflation gauge rose more than expected, traders bet it would likely force the Fed's hand. Futures markets began pricing in about a 90% probability that the Fed will raise rates by 25 basis points after its upcoming meeting. "The more the Fed can demonstrate its credibility in fighting inflation, the more likely it is to compress the risk premium at the long end of the Treasury curve over the medium term," said Daleep Singh, chief global economist at PGIM Credit. Even so, several other factors pushing yields higher remain in place. The federal deficit reached $2 trillion in the first 11 months of this fiscal year. Last week, Trump proposed that if Republicans retain control of Congress after the upcoming elections, he might send $5,000 checks to every American adult, with total spending exceeding $1 trillionwhich a White House economic adviser called a "serious proposal." The Middle East conflict also continues to escalate, pushing oil prices to a four-month high. The strategist team at JPMorgan led by Jay Barry said they expect a rate hike this week, but are "bearish" on long-end Treasuries because traders may react to the Fed statement and Warsh's news conference. Others also expressed caution, saying the selloff could reignite if the Fed surprises investors. "If the Fed does not raise rates, the selloff at the long end could become more disorderly," said Ed Al-Hussainy, a portfolio manager at Columbia Threadneedle.