Spooked by inflation, deficits, hocus-pocus shows, competition from the AI debt binge, and getting casually thrown under the bus by Trump’s free-money promise.

By Wolf Richter for WOLF STREET.

It was a brutal four-day week in the bond market and mortgage market, with yields surging across the board to price in more rate hikes, more inflation — two nasty inflation prints this week, the PPI and the CPI — more supply of Treasury debt to pile on top of the $40 trillion, more fiscal deficits, more competing debt issued by the AI hyperscalers, more whatever. And then Trump threw the whole bond market under the bus. The 1-year to 7-year maturities made the biggest moves: Their yields spiked by 22 to 26 basis points in those four days.

At the 3-year Treasury auction on Tuesday, it took a yield of 4.474% to sell all $58 billion of notes. In the secondary market, the 3-year yield then spiked by 25 basis points in three days and on Friday closed at 4.72%.

Since late February, the 3-year yield has spiked by 108 basis points – one heck of a majestic spike. The Fed rarely hikes policy rates just once. It usually does so in a series. And the three-year yield is now counting on 3 or 4 rate hikes to come: It’s 106 basis points above the Effective Federal Funds Rate (blue, 3.63% currently), which the Fed targets with its policy rates.

That’s the bond market in action without forward guidance from the Fed: Instead, buyers and sellers are steered by the data as they see it, and by how they think the Fed would or should react to that data.

The 2-year Treasury yield, which is one of the most important input data points for the Fed and its rate decisions, got even wilder, without auction this week, spiking by 26 basis points this week, and by 126 basis points since late February, to 4.63%, the highest since July 2024.

The buyers and sellers at this end of the bond market had flipped essentially from 1 rate cut in February, to 4 rate hikes on Friday.

Right or wrong, there’s going to be a lot of volatility in the bond market – and Fed boss Warsh, who despises forward guidance and wants the bond market to do its job, is secretly nodding in approval about this process of price discovery between buyers and sellers, rather than a bond market cowed and manipulated by the Fed’s forward guidance.

At the 10-year Treasury auction on Wednesday, it took a yield of 4.834%, the highest auction yield since August 2007, to sell all $39 billion of notes.

Then in the secondary market, the 10-year yield surged to 4.97% by late Thursday and on Friday clung to it, the highest yield since the intraday high of 5.02% on October 23, 2023, and before then, the highest since July 2007.

The worst inflation in 40 years forced the Fed to ease out of financial-repression mode in 2022 that it had been in since 2008. So it hiked its policy rates from near-0% and began to unload securities from its massive balance sheet, and yields began to rise across the board.

But a 10-year yield of 5% is not high, compared to the decades before the Fed’s financial repression.

Rising yields mean falling bond prices for existing bond holders. Especially those who’d believed the Fed’s forward guidance and bought long-term securities in 2020 and 2021 have gotten bloodied as these securities’ market value plunged by about half.

But potential buyers, sitting nearby on the fence, are licking their chops because bond yields are finally normalizing after 14 years of financial repression.

The 10-year yield is now 134 basis points above the EFFR (3.63%). Back in October 2023, when the 10-year yield spiked to 5% briefly, it was below the EFFR (5.33% at the time), and T-bills sold at auction with a yield of around 5.5%. Back then, the yield curve was inverted, with long-term yields lower than short-term yields.

At the 30-year Treasury auction on Thursday, it took a yield of 5.308%, the highest auction yield since August 2001, to sell all $22 billion of bonds.

In the secondary market, the 30-year yield rose to 5.36% by Friday evening.

The whole thing was made worse by Trump’s free-money promise ($5,000 for every adult American), which, if implemented, would add $1.3 trillion to the deficit and debt and would provide lots of fuel for further inflation.

That Trump would so casually throw the entire $40-trillion bond market under the bus with his left hand was an additional nightmare for the bond market.

Made worse by the Treasury buyback auction. Bessent had announced the buyback auctions in mid-August, which we called a hocus-pocus show at the time. The purpose was to manipulate down long-term Treasury yields.

On Wednesday, the government provided the details – it would offer to buy back $6 billion of 40 different issues of 20-year and 30-year bonds that would mature at dates ranging between May 2040 and August 2046. But Treasury yields jumped even more as the market had hoped a higher maximum, or no maximum at all.

Then on Thursday, when the buyback auction took place, yields jumped further. Sellers bid the lowest percentage of face value they were willing to accept for their bonds, and the lowest percentage (biggest haircut) won.

The biggest accepted haircut was for a 20-year bond that was issued in August 2020, maturing in August 2040, with a coupon interest rate of 1.125%. It sold at an average of 59.95% of face value.

The smallest haircut went to sellers of a 20-year bond that was issued in May 2025, maturing in May 2045, with a coupon interest rate of 5.0%. It was accepted at 95.84% of face value.

But sellers were high-balling the government, wanting to get higher prices than the government was willing to pay. Of the $10.5 billion offered, the government bought back only $5.2 billion, below the $6 billion cap. Given the discounts that the government obtained, it ended up paying substantially less than $5.2 billion to buy back those bonds.

The fundamental problem with the Treasury buyback auctions is that the government cannot print money, only the Fed can, and that the government has to eventually borrow every dime that it spends on buybacks, thereby replacing larger amounts of older low-interest-rate debt with smaller amounts of new higher-interest rate debt, with the net effect that the debt declines a little bit, while the total interest payments may rise a little bit.

Bloodbath in the mortgage market. The 30-year fixed mortgage rate tracks the 10-year Treasury yield, but is higher, and the spread between them varies. So the same dynamics played out in the mortgage market as in the Treasury market. Mortgage-backed securities (MBS) sold off sharply, and mortgage rates spiked.

The average 30-year fixed mortgage rate spiked by 23 basis points this week, and by 37 basis points in two weeks, and by 112 basis points since late February, to 7.12% on Friday, the highest since February 2025, according to the daily measure by Mortgage News Daily.

By casually throwing the bond market under the bus with this free-money promise, Trump also threw the mortgage market under the bus (chart via Mortgage News Daily).

Mortgage rates around 7% are not high in a historical context. They’re only high in the context of financial repression. Compared to certain other periods, they’re low.

Freddie Mac’s measure for the 30-year mortgage rates is a weekly average through Wednesday, thereby still missing the spike on Thursday and Friday. The weekly average though Wednesday rose to 6.76%. But the long-term chart shows the drift: the 7% range is not high compared to the rates that prevailed before 2008, before the Fed’s financial repression (green box). Mortgage rates peaked at over 18% in 1981.

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