5% US Treasury yield storm hits! The countdown to the refinancing bomb begins, who will be the first victim?

The Zhitong Finance App notes that 10-year US Treasury yields rose to their highest level since 2007 on Tuesday, pushing borrowing costs into a range that could reveal some of the weakest links in the financial system.

A number of industry veterans said that the problem facing investors is less and less about whether a yield of 5% or more will cause something to collapse right away, but rather where the pressure will show if interest rates remain at this level.

Market experts agree that a benchmark yield of 5% or more will gradually reveal vulnerability — as higher borrowing costs gradually spread to housing, commercial real estate, and highly indebted companies.

The biggest danger is that if interest rates remain high enough, borrowers who have heavily borrowed cheap debt in an era of zero interest rates will be forced to refinance at a significantly higher cost.

Jack Ablin, chief investment officer at Cresset Capital, said, “Be aware that 5% won't break anything the day it arrives. It will break things down after 12 to 18 months, that is, when refinancing must be completed at the new interest rate level.” The risk isn't at the level we saw this morning; however, the longer we stay in this position, the trickier the situation is likely to get.”

Housing is the first to be pressured

Housing is likely to be the most vulnerable link. As long-term treasury yields soar, mortgage interest rates are approaching levels that could further erode the affordability of buying a home.

According to Ablin, “the pressure is likely to first show up in the housing sector.” He said that as interest rates on 30-year mortgages are likely to approach 8%, existing homeowners with mortgages at around 3% are unlikely to sell their homes.

This means that the initial shock may not be a wave of defaults, but a further freeze in transaction volume — which will hurt homebuilders, mortgage lenders, title insurers, brokerage firms, and home improvement retailers.

Molly Brooks, an American interest rate strategist at TD Securities, also pointed out that housing is particularly sensitive because rising long-term treasury yields are directly transmitted to mortgage interest rates.

By contrast, the pressure felt by banks may come a little later — according to Billy Leung, investment strategist at Global X ETFs, provided that long-term high borrowing costs worsen the situation of real estate or corporate borrowers.

Brooks said that in the short term, steeper yield curves may initially support banks' interest spreads, because banks usually finance at shorter interest rates and lend at higher interest rates farther along the curve.

Countdown to refinance

As debt raised at interest rates far below the current point matures one after another, there may be serious credit pressure between businesses and real estate owners.

Billy Leung said, “The key issue is not necessarily the level of yield today, but the fact that in many cases, debt that was raised at an interest rate of 2% to 3% now needs to be refunded at an interest rate close to 6% to 8%.” This will put pressure on cash flow, asset value, and credit quality.”

Many companies extended their debt terms in 2020 and 2021, or later delayed repayments further, thereby delaying the impact of high interest rates. But “the key point is that the expiration wall has been moved, not removed.” Ablin said.

Ablin said he is watching for interest coverage in leveraged loans and signs of pressure in the private credit sector, including the rising share of borrowers using additional debt rather than cash to pay interest.

Leung emphasized that companies backed by leveraged loans, speculative credit, and private equity are particularly sensitive to higher financing costs for corporate and commercial real estate borrowers.

Commercial real estate is likely to be under particularly severe pressure. Ablin pointed out that office properties are inherently a weak link, and higher interest rates could make matters worse. Rising borrowing costs raise the cost of financing a property.

Ablin also pointed out the vulnerability of multi-family residential properties — these properties were funded with variable interest rate bridge loans in 2021 and 2022, when borrowing costs were far lower than they are now, and expectations for rent growth were more optimistic.

How long it lasts is more important than how high it rises

The strategists say the bigger question for the market is not that the 10-year yield has surpassed 5%, but how long it will stay at this level.

“I think the duration is more important than the exact level of yield.” Leung said. The market is usually able to absorb fluctuations that temporarily break through 5%, but if it continues for 6 to 12 months or more, it's hard to turn a blind eye.”

Ablin also expressed a similar opinion: if the 5% yield continues for two to three quarters, the pressure to refinance will become more and more difficult to avoid; a rapid rise may present another risk — disrupting hedging and forcing investors to readjust their positions.

Brooks emphasized that the composition of rising yields is just as important. If term premiums rise sharply and growth expectations do not improve accordingly, it means that borrowing costs are rising, but there is no stronger economic activity to cushion the impact.

“At this stage, I would still view 5% primarily as a valuation adjustment rather than an imminent systemic threat.” Leung said. However, the space for fault tolerance is narrowing.”