A strategist at Soochow Securities Company Limited. has noted that US Treasury yields continued their upward trajectory this week, with markets now pricing in not just a single rate hike, but the potential for a sequence of increases over the next six to nine months. These elevated expectations are already substantially reflected in current prices. Should the Federal Reserve refrain from hiking next week, a short-term recovery in bonds is plausible, though it would be unlikely to automatically evolve into a sustained rally given that oil prices, employment dynamics, and AI investment intensity show no signs of a clear reversal. Concerns over near-term inflation pressures and consecutive rate hikes will likely persist.

The strategist acknowledges a previous assessment was incorrect in underestimating two key developments. First, the persistence of oil price increases has exceeded forecasts. Rather than de-escalating, Middle East tensions continue to intensify. The anticipated moderating influence on the conflict has not materialised, leaving supply-side uncertainty elevated and preventing the expected pullback in crude prices. Second, August CPI was unexpectedly influenced by telecommunications prices, with core CPI rising 0.3% month-over-month against a 0.2% consensus forecast, partly driven by an anomalous surge in wireless communication service costs. While stripping out this distortion suggests underlying inflation remains near 0.2% – hardly indicating runaway domestic price pressures – the headline data failed to provide the Fed with sufficient confidence that disinflation is firmly underway.

The previous argument assumed inflation would ease, allowing long-end yields to drift lower even without a Fed move. That premise has shifted. The telecom price jump may prove transitory, but oil prices are a different matter. With Middle East tensions escalating and crude stubbornly high, markets are now trading not just current CPI, but the risk of energy costs feeding back into broader inflation in the months ahead. Inflation expectations are re-emerging due to seemingly unanchored oil prices, constraining the Fed's policy flexibility and necessitating a revised outlook for long-term rates. Rising short-term inflation pressure increases the likelihood of a rate hike, which would push up 2-year and 5-year yields, dragging 10-year and 30-year rates higher as well. As of September 11, the 2-year yield stood around 4.63%, the 5-year at 4.78%, the 10-year near 4.96%, and the 30-year at roughly 5.35%. The yield curve shows the 5-year 15 basis points above the 2-year, the 10-year 18 basis points over the 5-year, and the 30-year 39 basis points above the 10-year, indicating short-end yields are reacting more sharply to rate expectations.

The defining feature of this week is not a broad sell-off across all maturities, but outsized gains in 2-year and 5-year yields. This signals markets are repricing the Fed's policy path over upcoming meetings, with growing concern about consecutive hikes within the next six to nine months. Long-end yields are being pulled higher by the ascent in short and intermediate rates. The 30-year yield briefly traded in the 5.33% to 5.37% range ahead of a recent Treasury auction, though it retreated on Friday without posting a new meaningful high. The long end remains fragile, yet is attracting some buying interest as elevated yields draw in allocators, increasing resistance to further upward moves.

Three conclusions from the prior article remain valid. First, long-end rates are not solely determined by a single Fed meeting. Second, fiscal deficits, Treasury supply, and dollar credibility continue to anchor the long-term rate trajectory. Third, the 30-year yield is approaching levels that offer attractive allocation opportunities. However, a pullback from highs does not eliminate long-term risks, and the presence of buyers at elevated yields does not signal a completed trend reversal. The primary error in the previous analysis was over-optimism regarding declining inflation pressure, with the conflict in Iran and oil prices compressing the window for a bond rebound.

Many investors previously assumed the US held full control over the Iran situation – escalation followed US aggression, while retreat brought relief. That calculus appears outdated. According to public reports, Iran claims to have struck targets including American vessels. While the specific outcomes require verification across Iranian statements, US confirmations, and independent media reporting, markets are already trading a key shift: Iran can now actively influence the conflict's tempo. War is no longer unilaterally escalated or halted by Washington. Even a US cessation of offensive actions does not automatically conclude the conflict. Iran can raise the cost of continued US involvement through military operations, shipping threats, and regional unrest.

The oil price rally reflects more than just reduced crude supply today; it prices who controls the war's trajectory and its duration. Markets are also factoring in risks to Strait of Hormuz transit, tanker insurance premiums, shipping costs, energy infrastructure vulnerabilities, and how long the conflict might persist. The most likely scenario involves limited escalation and prolonged attrition, with both sides retaining military pressure while leaving room for negotiation. Oil prices will carry a risk premium with inflation pressures unlikely to ease rapidly in coming months. A less probable scenario involves outright conflict expansion, directly impacting shipping, energy facilities, or Hormuz passage, simultaneously pressuring both oil and rates. Should negotiations or a ceasefire emerge, the war premium in oil would quickly dissipate.

With US midterm elections approaching, rising oil prices add to household financial strain, and protracted conflict raises the political costs for the administration. Washington must weigh military actions against inflation and electoral pressures. This complexity distinguishes the current oil shock from typical energy price fluctuations, influencing not only inflation but also US foreign, fiscal, and monetary policy choices. Until oil prices retreat, any short-term bond recovery is unlikely to convert into a sustained uptrend.

US employment is showing resilience. August non-farm payrolls rose by 162,000, significantly outpacing the roughly 53,000 consensus. The unemployment rate held steady at 4.1%. Revisions show June employment increased by 31,000 (up from an initial 20,000) and July added 21,000 (revised from a 23,000 decline), combining for an upward revision of 55,000 in the two months. This suggests earlier weakness may have been overstated in initial releases. The August figure was not isolated, with average hourly earnings rising 0.3% month-over-month and 3.1% year-over-year. Average weekly hours were 34.4. Long-term unemployed individuals number around 1.9 million, accounting for 27% of the jobless total. The labour force participation rate is 61.6%, down 0.5 percentage points since the start of the year, with the employment-population ratio at 59.1%. Those working part-time for economic reasons fell to 4.4 million. These metrics point to a resilient yet not fully booming labour market.

Sector breakdowns offer further insight. Food services and drinking places added roughly 59,000 jobs, local government 35,000, manufacturing 16,000, and healthcare 13,000. The information sector shed about 23,000 positions, while computer infrastructure, data processing, and web hosting services lost approximately 8,000. This report does not definitively prove that artificial intelligence is driving job losses in the information sector, but it does illustrate that AI capital expenditure is boosting demand for data centres, equipment, power, manufacturing, and construction without translating into broad-based hiring. The AI boom currently manifests as capital-intensive expansion rather than widespread labour demand.

US August CPI rose 0.4% month-over-month and 3.4% annually, with core CPI up 2.4% year-over-year and energy prices surging 16.3%. Inflation is not out of control – secondary transmission effects from oil remain weak – but prices are not declining as rapidly as previously anticipated. As long as AI capital spending does not decelerate meaningfully, it will continue to fuel demand for equipment, electricity, construction, and resources, reinforcing market conviction that inflation pressures will not vanish quickly over the next six to nine months. Together, oil prices, employment, and AI investment elevate the credibility of consecutive rate hikes in the coming quarters.

Short and intermediate yields rose faster this week, with the 2-to-5-year segment climbing more sharply. This indicates policy trajectory was the dominant trading theme, with markets pricing in successive hikes over six to nine months. However, the 30-year yield's failure to post fresh meaningful highs suggests the long end, while fragile, is no longer a one-way market without buyers. Short-end rates have already partially discounted some rate-hike risk; even if the Fed does proceed with an actual hike, the upside for 2-year and 5-year yields may be more limited than previously feared. The long end is a different story. Fiscal deficits, Treasury supply, war risk, and dollar credibility continue to influence the 30-year yield. The emergence of buyers does not erase long-term risks.

Comparing current rates to historical episodes since 2007 reveals distinct phases: the high-growth, high-inflation, high-policy-rate environment around 2007; the 2013 "taper tantrum" characterised by rapidly rising long-end yields and risk premia; and 2022-2023, when inflation and consecutive hikes pushed yields up across all maturities. The present situation is more complex, with short-term inflation pressures re-emerging, employment resilient, AI capital expenditure expanding, and fiscal deficits along with Treasury supply continuing to grow. The current market structure resembles: short-end rates pre-pricing consecutive hikes; long-end rates absorbing fiscal and supply pressures; high yields beginning to attract allocation; and incomplete pricing of future inflation risks. Short rates have already priced in tightening, while long rates await genuine relief from inflation and fiscal concerns.

Based on market pricing, a rate hike next week is the higher-probability scenario. Oil is rising, jobs data shows resilience, CPI remains firm, and 2-year and 5-year yields are notably higher. These developments indicate markets are already trading expectations of consecutive hikes over six to nine months. If the Fed does raise rates next week, markets may not face a dramatic new shock, as these expectations are largely embedded in current prices. A single hike could trigger short-term volatility or a "sell-the-rumour, buy-the-news" drop in yields. The market's focus will be less on one hike and more on whether the tightening cycle extends. The strategist's inclination, however, is that the Fed will hold steady next week – the lower-probability scenario in market pricing. Oil's rise carries clear supply-shock and war-risk characteristics. Jobs data show resilience without broad-based prosperity. Core inflation is not accelerating uncontrollably. AI capital spending remains a persistent risk but has not fully translated into widespread services inflation. The Fed has no compelling reason to respond to all short-term shocks with a single hike.

If the Fed does not move next week, 2-year and 5-year yields could pull back, with expectations of consecutive hikes undergoing temporary correction. The 30-year yield might also gain temporary relief. This constitutes the short-term trading window for US Treasuries. But this window has clear boundaries. Oil prices have not materially declined, employment data have not significantly deteriorated, and AI capital spending has not slowed. Market expectations for consecutive hikes over the next six to nine months remain intact. A single pause does not alter these fundamentals. Consequently, while the 30-year yield is entering an attractive allocation zone, it should not yet be interpreted as a definitive bottom-fishing signal. Short-term traders may watch for rate repair; long-term investors can study allocation value. One should not mistake a temporary policy reprieve for a completed trend reversal in long-end rates.

Over the next six months, a sudden collapse in dollar credibility is unlikely. The scale of the US economy, depth of financial markets, and liquidity of dollar assets still provide support. Dollar credibility faces a gradual test: fiscal deficits continue widening, Treasury supply keeps growing, midterm elections draw near, and the Iran war raises policy uncertainty. Investors will demand higher yields to compensate for these risks. US Treasuries offer a short-term window, but this is not yet the moment for a durable reversal. A rate pause may prompt short-term repair, yet it cannot eliminate the risk of consecutive hikes over the coming six to nine months. A hike remains the higher-probability outcome in market pricing, though the hike itself may not be the biggest market shock. The short end awaits policy, the long end awaits the midterm elections.