US Treasuries suffer worst month in years as sell-off feeds on itself

US long-term Treasury yields continued to climb even as inflation came in below market expectations. The 10-year Treasury yield surged as high as 5.34% on Thursday (local time), its highest level since 2002. Market watchers are warning that US Treasury selling has entered a vicious cycle in which one wave of selling begets another.

The August personal consumption expenditures (PCE) price index, released Wednesday (local time), rose 3.4% from a year earlier, falling short of the market consensus of 3.7%. Core PCE, which strips out food and energy, also eased to 3.0% from 3.3% in July. As price pressures cooled faster than expected, bond markets initially responded to the slowdown.

Treasury yields dipped immediately after the PCE release, but the move did not last. Selling pressure on long-dated bonds reasserted itself, pushing the 10-year yield back above 5.3%. A stronger-than-expected US economy and supply-demand pressures at the long end of the curve proved to be the bigger drivers.

Also released that day, the US second-quarter GDP growth rate was sharply revised upward to an annualized 2.2% from an earlier estimate of 1.5%, as consumer spending and business investment turned out to be stronger than initially tallied. August consumer spending also rose 0.9% from the prior month. The resilience of the US economy despite high interest rates reinforced expectations that the Federal Reserve could keep its benchmark interest rate elevated for longer than anticipated, even without an immediate additional hike.

Another force pushing long-term yields higher is the supply-demand dynamic within the bond market itself. The US government continues to issue Treasuries at a massive scale to cover its enormous fiscal deficit, while corporations are simultaneously ramping up corporate bond issuance to fund investment in AI data centers, semiconductors and power grids. With both the government and the private sector tapping the bond market at the same time, a structure is emerging in which they compete for a limited pool of investor capital.

The Wall Street Journal reported that large-scale Treasury supply driven by fiscal deficits, combined with heavy corporate bond issuance to support AI infrastructure investment, could widen the term premium on long-dated bonds and exert sustained upward pressure on Treasury yields. Patrick Munnelly, a market strategist at Tickmill Group, said the widening term premium stemming from fiscal deficits, Treasury supply and AI infrastructure-related corporate bond issuance remains a fundamental risk that could push yields higher again.

When bond supply increases, issuers must offer higher yields to attract buyers. When US government Treasuries and corporate bonds for AI investment flood the market simultaneously, investors may opt for the higher-yielding corporate paper over Treasuries — putting upward pressure on Treasury yields as well, as they compete for the same pool of buyers.

As a result, the forces driving US long-term yields appear to be shifting beyond the Fed's monetary policy to a broader combination of strong growth, government debt and private-sector capital demand. Unlike short-term bonds, which are sensitive to monetary policy expectations, the 10-year and 30-year maturities are increasingly being shaped by economic growth, fiscal deficits and the term premium arising from Treasury and corporate bond supply.

The deeper concern is that this anxiety is being amplified by mechanical selling within the market itself. The Financial Times, citing large investors and traders Wednesday (local time), reported that a Treasury sell-off that began with concerns over the United States' massive public debt and inflation has now begun triggering additional selling by various funds. As Treasury yields climbed to certain levels, some funds found themselves obligated to sell US Treasuries, and that selling pushed bond prices lower still — driving yields higher and setting off yet another round of forced selling.

Rising US Treasury yields mean falling prices. Some funds — particularly those using leverage or operating under strict risk-management rules — cannot simply ride out a decline beyond a certain threshold. They may be required to reduce their Treasury holdings to comply with loss limits, margin requirements, volatility caps or value-at-risk (VaR) rules. When multiple funds facing such pressure sell simultaneously, Treasury prices fall further and yields rise even more.

The result is a feedback loop: rising Treasury yields push prices lower, inflicting losses and increasing volatility for funds, which then breach risk limits, triggering forced selling that drives prices down further and yields higher still.

"We are in this vicious cycle right now," said Priya Misra, portfolio manager at JPMorgan Asset Management. "I'm not sure what breaks it." She added, "This can go on for a while. Nobody wants to stand in front of a freight train."

Amrut Nashikar, an analyst at Barclays, said leveraged funds holding large positions in US Treasury futures are rebalancing their portfolios, triggering additional selling. Daniel Gottlander, Citi's head of North America swap trading, said, "When markets sell off like this, you have to reduce risk in other parts of the portfolio as well. That's why all the selling happens at once. The spillover into other markets is also significant."

Normally, when bond prices fall far enough, buyers emerge and the market stabilizes — but experts say that dynamic has not materialized this time. "We haven't seen the marginal buyer yet," Gottlander said.

This is the backdrop for growing expectations that long-term yields may not easily return to the low levels of the past, even if inflation stabilizes and the case for further Fed rate hikes weakens. Market attention is also broadening — shifting from "how much more will the Fed raise rates?" to "what yield will it take to persuade investors to absorb the flood of bonds being issued by the government and corporations?"