Strong demand at recent US Treasury auctions has drawn institutional investors back into the market as yields reach multi-decade highs, even as analysts warn that European fiscal and political stresses could spill over and trigger a new period of global bond market volatility.

At midday Thursday local time, as the 30-year Treasury yield climbed to its highest level since 2007, a $22 billion auction of 30-year notes drew exceptionally strong demand, clearing at a yield of 5.308%. Demand was so robust that primary dealers received only 2.2% of the issue, a record low. A day earlier, a $39 billion auction of 10-year notes also saw strong demand. With yields at multi-decade highs, some institutional investors have begun bargain-hunting in Treasuries. Yet market participants remain concerned that France's debt crisis and Spain's political unrest, combined with America's own structural fiscal deficit, could push the global bond market into a new cycle of turbulence.

John Briggs, head of US rates strategy at Natixis, said turmoil in the European bond market is transmitting to the US Treasury market. Deteriorating European fiscal positions and political instability are now intersecting with the outlook for US midterm elections, potentially amplifying bond market volatility in the near term.

High US Treasury Yields Begin to Attract Institutional Investors

The US Treasury's $39 billion 10-year note auction cleared at a yield of 5.3%, notably below the secondary market yield before the sale, signaling strong investor demand. The bid-to-cover ratio rose to 2.77 times, the highest since 2016. The share allocated to non-dealer investors reached a record 97.5%. Monty Gandhi, a rates strategist at Sumitomo Mitsui Banking Corporation (SMBC), said the auction showed that large, well-capitalized investors have begun to view current yield levels as attractive. In fact, when yields approached 5% earlier, some large investors had already started to unwind short positions in Treasuries and may now be gradually buying back in.

After the auction results were released, long-dated Treasury yields gave back part of their intraday gains. The 10-year Treasury yield fell back to around 5.28%, well below the 5.36% touched earlier in the day. Notably, 5.36% was a level unseen since 2002. The 30-year Treasury yield rose only about 1 basis point to 5.67%, having climbed further earlier on rising oil prices. Short-dated Treasuries performed relatively more strongly, with the 2-year yield falling about 3 basis points to 4.76%.

On Monday, the 10-year Treasury yield rose intraday to 5.349%, a 24-year high, and climbed 0.87 percentage point in the third quarter alone, the largest quarterly increase since the first quarter of 1994. The 30-year yield also touched 5.703%, likewise the highest since May 2002. Global bond markets have been under sustained pressure in recent weeks. Elevated energy prices have intensified fears of rekindled inflation and further central bank rate hikes; on Wednesday, Brent crude futures briefly topped $102 a barrel. Meanwhile, companies issuing corporate bonds to raise large sums for artificial intelligence (AI) infrastructure buildout are adding supply. Morgan Stanley forecast in July that AI-related corporate bond issuance would more than double this year from last year to $570 billion.

Evelyne Gomez-Liechti, a multi-asset strategist at Mizuho International, said the Treasury market is currently caught between two opposing forces. On one hand, absolute Treasury yields have reached quite attractive levels. On the other, inflation risks from higher oil prices have yet to fade. Briggs said some signs of stabilization have emerged over the past week, especially at the short end of the yield curve, and investor demand is now appearing at the long end as well. While it is still too early to say the Treasury selloff is over, the strong 10-year auction at least sends a positive signal.

US Treasury Secretary Bessent said again at a White House event on Wednesday that the recent rise in bond yields is a "global phenomenon." Unlike other economies, the rise in Treasury yields mainly reflects higher real interest rates rather than worsening inflation expectations, an important reason being that US economic growth remains strong. Bessent also reiterated that once the Iran conflict eases, energy prices are expected to decline, and market rates across maturities should then fall as well. At the same time, the short-end Treasury curve has recently shown some signs of stabilization. Last week's inflation and labor market data came in weaker than expected, and several Federal Reserve officials struck relatively dovish policy tones, leading the market to scale back expectations for further Fed rate hikes. Interest rate swap markets now put the probability of a Fed hike in October at about 25%, though another hike before year-end is already fully priced in.

Is European Bond Turmoil Transmitting to US Treasuries?

Still, the market remains worried that France's debt crisis and Spain's political unrest, combined with America's own structural deficit, could push the global bond market into a new cycle of turbulence. On Monday, the 10-year French government bond yield rose to its highest since 2002, and its spread over German bunds widened to the widest since the European debt crisis. The 30-year UK gilt yield rose intraday to 6.020%, the highest since 1998, and the first time a G7 member's long-dated government bond yield has exceeded 6% since the 2012 European debt crisis. Meanwhile, as hedge funds' arbitrage positions in European government bonds were unwound en masse, Italian and Greek government bond yields also jumped sharply. Eurozone inflation rose 3.8% year-on-year last month, the largest increase since September 2023.

Briggs said turmoil in the European bond market is transmitting to the US Treasury market. Wall Street does not yet believe the European situation will escalate into a crisis on the scale of 2009-2012, but European uncertainty has become a new variable in the Treasury selloff. Europe's fiscal pressure is most concentrated in France. France's national debt reached 3.596 trillion euros as of end-June, or 119% of GDP, and this year's fiscal deficit is expected to widen to 5.4% of GDP from 5.1% last year. In the draft budget released on October 1, the French government proposed cutting 43 billion euros in spending, with education spending rising only 1.7% in nominal terms, below the inflation rate. With France's fiscal outlook far from rosy, global investors are accelerating their exit from its bond market. Statistics show Japanese investors have net sold about 356 billion yen of French government bonds so far this year. Spain's housing shortage is also weighing on the bond market. On September 23, an 87-year-old Spanish man was evicted from a Madrid apartment he had lived in for more than 70 years because his pension could not cover soaring rent, sparking street protests.

Briggs added that beyond the transmission risk from European bonds, multiple structural factors are combining to push Treasury yields persistently higher. The ongoing Middle East conflict and elevated oil prices keep the risk of rekindled inflation alive. At the same time, the Trump administration's tax cuts and increased military spending tied to the Middle East conflict are sharply expanding the fiscal deficit, and the supply of US Treasury debt keeps growing, creating a vicious cycle of rising yields.