The Federal Reserve has just increased interest rates, the 10-year Treasury yield is currently close to 5 per cent, and investors ranging from those in Tokyo to those in London are now being compelled to think again about the value of every stock, bond and currency.
The biggest interest rate in the world might not be the one on your mortgage, nor that on your credit card, or even the Federal Reserve’s overnight policy rate. At the moment, it could be the yield on the 10-year U.S. Treasury, which was around 4.93% on September 22 having risen above 5% earlier this month. This rate is important since Treasuries act as a benchmark for borrowing and for asset pricing in a large part of the global financial system, according to Reuters.
On September 16 the Federal Reserve introduced further pressure by raising its target range for the federal funds rate by 25 basis points to 3.75% to 4.00%, marking its first increase in more than three years. The Fed stated that economic activity had stayed strong but that “inflation remains elevated.” More significant for the markets, the Fed’s most recent projections indicate that the median policymaker now expects the federal funds rate to end at 4.1% in 2026, a sharp rise from the 3.8% forecast given in June, according to the Federal Reserve.
This results in a rather unusual global investment situation since American stocks are once again nearing record levels, AI firms are drawing in huge amounts of capital, and yet investors are at the same time able to gain almost 5 per cent by investing in longer-term U.S. government debt. When an investor is faced with the choice of buying an expensive technology stock, financing an emerging-market company or lending to a European government, the difficulty of making such a decision has all of a sudden become considerably greater. It’s not merely an issue concerning American interest rates any longer; the cost of America’s borrowing is now becoming the price that the rest of the world has to compete against.
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What does a Treasury yield of near 5 percent really signify? If an investor is considering a risky company, a property project or a foreign bond, they have to consider why the expected return is attractive given that U.S. government debt is already providing a high yield. Treasuries are usually regarded as the benchmark asset of low credit risk in dollar markets, even though international investors still have to contend with currency risk. The higher the benchmark yield becomes, the more return investors tend to require from other investments.
It can quietly affect the prices of shares. A company that is expected to earn a profit many years in the future becomes less valuable now when investors apply a higher interest rate to discount those future profits. It can also influence the way companies raise finance; those which issue bonds have to compete with Treasury yields and as a result often have to offer investors even higher rates in order to make up for the credit risk.
The impact does not end at the U.S. border. Research carried out by the Bank for International Settlements has shown that there are significant spillover effects from changes in U.S. Treasury yields into bond markets in both developed and developing economies. More recent studies by the BIS have revealed that unexpected developments in the American economy have become increasingly important in determining foreign bond yields, United States Treasury markets having a considerably greater influence on bond markets in other developed economies than those markets have on the United States. What it means is that an American inflation report which is hot can tighten financial conditions thousands of miles away even if no central bank in another country takes any action.
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The fact that it is an international matter makes this especially significant. The Federal Reserve is not acting on its own. On September 10, the European Central Bank increased its three main interest rates by 25 basis points, citing inflation pressures which are in part due to the Middle East conflict. Its economists now anticipate that euro-area inflation will average 3.0% in 2026.
Japan has likewise adopted a more restrictive policy, while investors keep a close eye on the yen. According to Reuters, global bond yields have been reacting to the same combination of energy prices, concerns about inflation and expectations of tighter monetary policy which have caused rising borrowing costs in the United States. On September 22, falling oil prices gave the markets a degree of relief and helped bring the U.S. 10-year yield back toward 4.93%, but the expectations of further tightening by central banks have not vanished.
The situation in emerging markets involves an even more difficult assessment. A study by the Bank for International Settlements looking at past instances of rapidly rising U.S. Treasury yields showed that in some cases this was linked to currency depreciation, falling asset prices and major capital outflows from emerging economies. Two factors raised the risk of problems: a rising U.S. term premium and a stronger dollar.
It doesn’t follow that every rise in Treasury yields leads to a crisis in emerging markets. The BIS itself has found that many earlier rises caused only minor damage. However, the mechanism is important: if assets denominated in dollars suddenly provide investors with a more attractive return, countries and companies in other places may have to pay more in order to keep their capital. A stronger dollar can make it harder for borrowers who have dollar-denominated debts but whose income is received in local currencies.
On Tuesday the dollar index stood at 100.48 and investors were still considering the possibility of another rise by the Federal Reserve. According to Reuters, market prices indicated about even odds of a further increase at the Fed’s next meeting, showing just how rapidly assumptions regarding the rate path are changing.
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There is another reason why investors should focus on the 10-year Treasury rather than just keeping an eye on the Fed: the two interest rates are not influenced by the same factors. The Federal Reserve has direct control over short-term interest rates, while long-term Treasury yields are determined in the market and take into account expectations regarding future inflation, future economic growth, future Fed policy and the additional return that investors require for holding debt for a number of years; it therefore remains possible for the 10-year yield to stay very high even if investors at a later stage start expecting the Fed to cease raising rates.
It is in this area that America’s fiscal position comes into play when it comes to the investment aspect. In order to finance its deficits and to refinance its existing debt, the federal government has to have a large amount of Treasury securities purchased by investors. As a result, worries regarding inflation, government borrowing and the future supply of Treasuries can lead longer-term yields to rise regardless of when the Federal Reserve meets next. Just this month global bond markets showed that kind of tension, with borrowing costs in the United States, Germany and Japan approaching levels not seen for years or even decades, according to Reuters.
A reasonable counterpoint can be made. High Treasury yields do not necessarily indicate financial difficulty; they may instead be due to robust economic growth and investors who expect stronger activity in the future. The Federal Reserve’s September forecasts had the effect of increasing the expected U.S. real GDP growth for 2026 to 2.3% and at the same time reducing the projected unemployment rate to 4.1%. Should inflation decline without harming growth, the Treasury yields could go down and a large part of the present pressure on global assets could be alleviated.
It is already possible that oil is giving an indication of this. On September 22 Brent crude fell sharply as expectations regarding supply in the Gulf improved, which in turn caused global bond yields to drop, according to Reuters. Should energy prices continue to fall and inflation do the same, the market might start to undo some of the extra rate hikes that are currently built into expectations. Yet that sense of relief has not yet come.
For global investors the main question is now bigger than simply whether the Federal Reserve will raise its rates by another quarter point; the real issue is how long America can maintain yields at around 5% before the capital in the rest of the financial system has to readjust to that level. When one of the world’s safest and most liquid assets starts paying investors close to 5%, almost everything else has to answer a difficult question: What reason is there for investors to take on more risk unless they are being paid a lot more for doing so? It could be the underlying reason why America’s interest-rate problem is turning into everybody else’s problem.
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