The global AI-fueled bull market is encountering fresh headwinds as U.S. inflation re-accelerates and Middle East conflicts intensify, putting upward pressure on the benchmark 10-year Treasury yield, a key determinant of global asset valuations.

While a softer-than-expected U.S. core CPI reading eased immediate pressure on the Federal Reserve to tighten policy, persistent headline inflation and escalating tensions with Iran have kept bond traders betting on a return to rate hikes by year-end. The U.S. military's new strikes on Iranian targets and Iran's subsequent closure of the Strait of Hormuz to all shipping, threatening attacks on any vessel attempting passage, are dynamics expected to further fuel inflation expectations and drive the 10-year yield higher.

After initially falling post-CPI data, Treasury yields resumed their climb later in the trading day, tracking rising oil prices and news of the Strait's closure. Pricing in interest rate swaps markets shows traders are fully pricing in a Fed rate hike by December, a view mirrored in the bond market. The CME FedWatch Tool also shows consensus for a December hike, with some bets even placed on an October move.

The May CPI report reinforced the 'higher for longer' interest rate narrative, though not strongly enough to trigger an immediate hike, with the Fed likely to hold steady for the coming months. However, a continued rise in both headline and core inflation, coupled with worsening Middle East geopolitics, will push U.S. inflation expectations and the 10-year yield higher, significantly cooling the AI-led global market rally.

Following former President Trump's threats against Iran, WTI crude futures surged over 4% during Wednesday's session, closing above the key $90 level, while Brent crude for August delivery gained nearly 2%, approaching $95. With strong non-farm payrolls, persistent headline inflation, escalating U.S.-Iran tensions pushing oil higher, and the Strait of Hormuz facing closure, the upward trajectory for the 10-year yield appears unavoidable in the near term.

On May 19th, the 10-year yield violently spiked to 4.7%, its highest level since January 2025, briefly dealing a significant blow to the AI-driven super-bull market and global equity momentum. As the risk-free rate anchor in DCF valuation models, a persistently high 10-year yield may not end the AI bull market but will subject it to near-term downward pressure, potentially shifting its character from a 'valuation expansion' phase to an 'earnings validation' phase.

Rising 10-year yields tend to severely compress the valuation of long-duration assets like high-PE semiconductors, AI software, unprofitable AI infrastructure, and futuristic tech sectors. For established AI hardware leaders with locked-in orders, pricing power, buyback capacity, and strong cash flows, the impact is more likely to be periodic volatility rather than a fundamental breakdown in their investment thesis.

Furthermore, if the Fed under Chair Warsh abandons its 'dot plot' and forward guidance as part of a 'path of change,' it could increase market uncertainty over the Fed's rate path, significantly raising term premiums and further strengthening the upward momentum for the 10-year yield.

Soft Core Inflation Meets Hard Oil Shock: Traders Still Bet on 2024 Rate Hike

The core Consumer Price Index, which excludes food and energy, rose 0.2% in May from April, below the 0.3% consensus forecast. However, headline inflation remained hot, highlighting the ongoing pressure from rising international oil prices due to Middle East geopolitics. Driven by energy cost increases from the regional conflict, U.S. headline inflation re-accelerated in May, with the CPI rising 0.5% month-over-month and 4.2% year-over-year.

This 4.2% annual increase, up from 3.8% in April, marks the highest level since April 2023 and signifies U.S. inflation returning above 4% for the first time in three years. The CPI report suggests the oil price shock hasn't yet broadly spilled over into the wider economy. Economists still see a high bar for the Fed to restart hikes immediately, expecting it to hold the federal funds rate target range at 3.50%-3.75% at its next meeting, though it may drop previous dovish language or policy bias.

Market pricing, however, shows traders have not withdrawn their hike bets, firmly expecting a December move. Goldman Sachs has also adopted a more cautious stance. The Wall Street giant, which previously forecast Fed rate cuts in December 2026 and March 2027, has now pushed those expectations back to June and December 2027. It cites tariff-driven inflation persistence, high oil prices, the Middle East war's impact, and AI-related financing needs as factors that could keep core PCE inflation above 3% through 2026.

Goldman's chief U.S. economist, David Mericle, replaced the bank's prior two-cut forecast for 2026 with a prediction for two 25-basis-point cuts in 2027. The report outlined four conditions that must be met before the Fed acts: 1) easing of tariff-related disruptions, 2) subsiding oil price pressures from the Iran conflict, 3) normalization of what Goldman sees as "exaggerated AI demand," and 4) core PCE inflation moving closer to 2%. Goldman assigns only a 30% probability to this new base case, with the remaining 70% covering outcomes from "no cuts" to "small hikes."

Dan Carter, a senior portfolio manager at Fort Washington Investment Advisors, noted the softer core CPI doesn't fundamentally ease bond investors' fears that the Fed will have to hike to combat war-induced price increases, but it does give the central bank more time to deliberate. "If you get another hot month, that puts a lot more pressure on them to hike. But this was just soft enough that they can wait and see," he said.

Prior to the report's release, traders in the SOFR options market had been building large positions targeting multiple Fed hikes in the coming months. Following last Friday's surprisingly strong jobs report, some option traders even accepted bets on action as early as September. These moves capped a significant hawkish repricing in bond markets since late February, when U.S.-Israel joint strikes on Iran triggered a rapid oil price surge, upending prior market bets that the Warsh-led Fed could deliver the rate cuts advocated by former President Trump.

A relatively optimistic sign is that the core inflation measure helps strip out the short-term impact of spiking energy costs. Despite headline CPI hitting a three-year high of 4.2%, the modest rise in core prices suggests a broader inflationary spillover from the oil surge has not yet materialized. David Kelly, chief global strategist at J.P. Morgan Asset Management, stated, "Seeing a 4-handle certainly isn't pretty, and there's clearly no reason to ease policy right now, but I think the Fed can stay on hold." With inflation essentially at the unemployment target level, Chair Warsh may have little intention of "leading the charge for the rate cuts Trump is eager for."

Oil prices continue to grip Treasury market nerves amid uncertainty over how long Middle East supply will be constrained. The 10-year and 30-year Treasury yields hit session highs during U.S. afternoon trading, moving in sync with benchmark crude, which extended gains to over 4% following Trump's latest threats against Iran.

A relatively positive development for the 10-year yield was a strong $39 billion 10-year Treasury auction, which produced a yield of 4.538%, slightly below market expectations, indicating solid demand. A $22 billion 30-year auction is scheduled for Thursday.

AI Super-Bull Market Faces Another 'Stress Test' as the 'Anchor' Rises

For the global AI equity bull market, the near-term danger lies not in cooling AI compute demand or capital expenditure, but in the renewed ascent of the 'global asset pricing anchor'—rising inflation risk premiums, term premiums, and the potential Fed rate path—which increases discount rates, pressuring highly valued AI tech assets.

If the Warsh-led Fed indeed downplays forward guidance as expected, strong jobs data continues to boost hike probabilities, and oil prices remain historically high, a key driver of the recent global equity bull market—the AI super-cycle—will face significant near-term pressure and likely a correction. Tech stocks within the AI infrastructure chain with the richest valuations, highest leverage, and most distant cash flows would be the first to come under pressure.

The Strait of Hormuz is one of the global energy system's most critical chokepoints. According to EIA statistics, 2024 oil flow through the Strait averaged about 20 million barrels per day, roughly 20% of global liquid consumption, with Q1 2025 flows broadly similar. If the Iran situation escalates further and oil stays high, the market will reprice inflation expectations, term premiums, and real rate expectations, potentially driving the 10-year yield even higher.

For global tech stocks, cryptocurrencies, and other risk assets, a key threshold lies in the 4.5%-4.8% range for the 10-year yield. Technical analysis suggests a break above the 4.70%-4.80% zone could reconfirm an uptrend. As the risk-free rate rises, equity risk premiums compress, significantly limiting valuation expansion potential. This implies that with the 10-year yield around 4.5%, the market can still rely on AI-driven earnings upgrades and risk appetite. However, if the yield effectively breaks above 4.70%-4.80% and approaches 5%, the high-valuation AI-related tech assets that have powered the global market rally will face stronger discount rate headwinds.

While AI compute leaders like NVIDIA Corp (NASDAQ: NVDA), Advanced Micro Devices Inc (NASDAQ: AMD), Micron Technology Inc (NASDAQ: MU), Taiwan Semiconductor Manufacturing Co Ltd (NYSE: TSM), and SK Hynix Inc (KRX: 000660) are supported by real revenue growth, order visibility, and capital expenditure, their valuations are ultimately priced as long-duration assets, highly dependent on the discount rate applied to future cash flows. Therefore, as the 10-year yield rises, increasing the discount rate for future cash flows, AI-related stocks with high P/E ratios, high sales multiples, and distant free cash flow realization are often the most vulnerable to valuation compression.

If the 10-year yield advances from around 4.5% toward 4.75% or 5%, the market will recompress forward P/E multiples, especially for AI data center chain stocks that have already priced in years of high growth, have free cash flow realization far in the future, and require massive ongoing capital expenditure. Recent stock market pricing logic has oscillated between AI-related bullish sentiment and the headwinds of high oil prices from a prolonged Hormuz closure, rising inflation expectations, and Treasury yield shocks, highlighting that the latter three factors are already simultaneously dampening risk appetite across both equity and bond markets.