Key facts
- Demand for short-term protection against a jump in 10-year US swap rates pushed the cost of insuring against a 200-basis-point rate rise over three months to 132 bps on Monday.
- Implied volatility for one-month options on 10-year swap rates has climbed to 21.4 basis points, the highest since late March.
- Goldman Sachs predicts that AI hyperscalers could sell a record $420 billion in debt next year.
- The 10-year/30-year Treasury yield curve spread widened to about 37 basis points this week.
- Investors are demanding a greater premium to hold the longest-dated government debt, reflecting a rising term premium.
The US bond market is facing significant stress, with yields climbing to levels not seen in over two decades. Investors are closely monitoring technical indicators that suggest potential for further yield increases, creating a feedback loop that could amplify market volatility. However, some anticipate that buyers may soon enter the market to secure current high yields.
One indicator of rising concern is the increased demand for protection against higher yields in the options market. The cost of insuring against a 200-basis-point rise in 10-year US swap rates over the next three months reached 132 basis points on Monday, the highest level since the March 2023 banking crisis. Implied volatility for one-month options on 10-year swap rates has also risen to 21.4 basis points, reflecting growing uncertainty.
Corporate issuance, particularly to fund AI buildouts, is contributing to the selloff. Goldman Sachs forecasts that AI hyperscalers could issue a record $420 billion in debt next year, potentially leading to increased hedging or selling of government securities. Investors in longer-term corporate bonds are using the Treasury market to hedge their duration risk, which can spur further selling.
Investors exposed to mortgage assets are also increasing their hedging against Treasury market selloffs. Rising rates extend the expected life of mortgage-backed securities, increasing their sensitivity to yield movements. This convexity hedging often involves selling Treasury futures, adding to selling pressure.
The widening of the 10-year/30-year yield curve spread to approximately 37 basis points this week signals that investors are demanding a higher premium for holding long-dated government debt. This steepening, occurring at already high yield levels, suggests a rising term premium rather than a broad repricing of Federal Reserve policy, indicating investor concern about the US fiscal picture.