Treasury Yields of 2 Years & 3 Years Spike toward 5%, but 10-Year Holds at 5%, Yield Curve Bulges: Some Thoughts on What’s Brewing

The 2-year and 3-year yields indicate that the 10-year yield could go way higher over the next few months.

By Wolf Richter for WOLF STREET.

The 3-year Treasury yield spiked by another 14 basis points this week – the week of the Fed’s hawkish rate hike – and by 56 basis points since Warsh’s financial-conditions-are-not-restrictive speech in Jackson Hole on August 28. Since the end of February, it has soared by 144 basis points. It closed on Friday at 4.86%, the highest since April 2024. That was over four months before the first round of rate cuts even started.

The yield is now just 15 basis points below the 10-year yield, which makes for a narrow spread. More on that in a moment. For many investors, that narrow spread and proximity to 5% would make the 3-year maturity attractive. But that demand hasn’t emerged, and the yield kept spiking on Friday by 8 basis points.

It’s 95 basis points above the Effective Federal Funds Rate (EFFR, blue in the chart), which the Fed targets with its policy rates. So these buyers and sellers in the bond market are now counting on multiple additional rate hikes, on top of the rate hike this week.

The 2-year Treasury yield soared by 13 basis points this week and by 56 basis points since Warsh’s speech. Since the end of February, it has soared by 134 basis points.

It closed at 4.76% on Friday, the highest since June 2024, about three months before the first round of rate cuts had even started.

It’s 88 basis points above the EFFR, thereby also pricing in multiple rate hikes. And it’s now only 25 basis points below the 10-year Treasury yield.

But the 10-year Treasury yield has gotten stuck at around 5%. It had been within a hair of 5% last week, rose to 5% this week, and after a drop on Thursday, bounced back on Friday and closed at 5.01%. This 5% is the magic line for the 10-year yield.

Last time it pierced 5% briefly intraday on October 23, 2023, the floodgates of demand opened, and investors jumped off the fence and started buying hand over fist, and the yield plunged that very day, and kept plunging for two months [Some thoughts on the Treasury yield above 5%].

This time around, the floodgates did not open, but there was enough buying to balance out the selling, and the yield got stuck at 5%.

Signs the 10-year yield might break through the 5% line over the next few months: While the 2-year and 3-year yields continued to soar, the 10-year yield kept bumping into the 5%, and each time it hit that magic number, more demand emerged and kept it from going over 5%. This dynamic has narrowed the spread to the 3-year yield to just 15 basis points, and to the 2-year yield to just 25 basis points.

In the past, during periods of economic growth and inflation, such as now, the spread between the 2-year yield and the 10-year yield spent lots of time in the range of 100-250 basis points.

This narrow spread today, and the much wider spread during times of growth and inflation indicates that the 10-year Treasury yield at today’s level is still well below where it might end up going, according to buyers and sellers in the 2-year and 3-year maturity portion of the bond market.

The 30-year Treasury yield has gotten stuck at the 5.35% range over the past two weeks and closed on Friday at 5.34%.

This range is the highest since 2007, the last year before the Fed’s QE and financial repression drove a wooden stake through the heart of the bond market and buried it in an unmarked grave – from which it started rising in 2022.

So maybe all that happened is that the long-term Treasury yields are in the process of normalizing as the bond market is coming back to life, with the encouragement of the Fed under Warsh.

The Treasury Yield Curve has steepened in the 1-year to 3-year range but flattened out in the 4-year to 10-year range, which brings us back to where the 10-year yield might be going, according to the buyers and sellers in the 2-year and 3-year maturities portion of the bond market.

The chart below shows the yield curve of Treasury yields across the maturity spectrum, from 1 month to 30 years, on three key dates in 2025 and 2026:

Red line: Friday, September 18, 2026.
Gold dotted line: July 31, 2026, two days after the no-rate-hike FOMC meeting.
Blue dotted line: September 16, 2025, before last three rate cuts.

The Fed’s rate cuts last year pushed down short-term yields, but longer-term yields rose as the bond market was worrying about inflation and deficits.

The chart also shows that since the eve of the Fed’s last round of rate cuts, since September 16, 2025, the 2-year yield and the 3-year yield have risen by the most.

Now there is this bulge in the middle (red line), indicating that this section of the bond market thinks the 10-year yield has still some ways to go higher, while enough buyers of the 10-year maturities are still enthralled by the 5% magic line.

Before the financial repression era that began in 2008, a 10-year Treasury yield at 5% was not high. It’s only high compared to the years of financial repression, starting in 2008, when the Fed purchased trillions of dollars of Treasury securities and MBS to artificially force down long-term yields. But this experiment ended in early 2022 amid 9% inflation, the worst in 40 years, and the worst home-price explosion ever that is now called the “affordability crisis.”

Warsh has been an outspoken critic of the Fed’s QE and ZIRP policies after the first round of QE and resigned from the Fed over this issue in 2011. And now he has welcomed with open arms the bond market coming back to life.