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U.S. Treasury bond yields continued to rise Wednesday, taking two-year borrowing costs to the highest level in more than a decade, as investors crept back into riskier equity markets and calibrated the impact of faster inflation from the ongoing U.S.-China trade war.

Benchmark 10-year U.S. Treasury bond yields hit a four-month high of 3.07% in overnight trading, while 2-year notes changed hands at a decade high of 2.816%, as investors adjusted fixed income portfolios for faster inflation, which could be triggered by the application of import tariffs that will filter-through to consumer prices in the back end of the year.

In fact, the CME Group's FedWatch tool, which assigns probabilities for future Federal Reserve rate hikes, is pricing in a more than 50% chance of a Fed move in March of next year for the very first time, a move that would take the central bank's key rate to a range of 2.5% to 2.75%, up from its current 1.75% to 2% band. The next hike is expected next week following the Fed's two-day meeting in Washington. 

President Donald Trump's decision to ally a 10% tariff on $200 billion worth of China-made goods, a figure that could rise to 25% by the end of year and could be matched with similar levies on $267 billion in consumer imports, has the potential to raise consumer prices and stoke inflation.

That concern was underpinned by last month's employment data from the Commerce Department, which said 201,000 new jobs were created in August and average hourly wages rose 2.9%, the fastest pace in nine years.

European bond markets are also seeing notable rate moves, with benchmark 10-year bund yields nearing 0.5% for the first time in nearly two months, extending its September rise to 15 basis points, ahead of the sale of €3 billion ($3.51 billion) in notes from the German government later today.

"Rising sovereign bond yields around the world are driving a weaker USD and a weaker JPY due to the ability of risk sentiment to rally at the same time," said Saxo Bank's head of FX strategy John Hardy. "Yes, in many cases the US rate rises are a bit sharper than elsewhere, but the sense of some convergence nonetheless (core EU yields have risen nearly as fast as US yields) is helping other currencies to keep pace with the greenback and even rally sharply."

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One lingering concern for the bond market, however, could be the fact that Treasury data should China's holdings of U.S. government debt fell to $1.171 trillion in July, a seven month low, even as its trade surplus continued to expand and now sits at a year-to-August record of $192.63 billion.

Another could be the fact that U.S. government debt has risen from around 54% of GDP prior to the financial crisis to round 94% this year, thanks in part to the need to fund last year's Republican-led tax cut, which will swell the nation's budget deficit to record $1 trillion this year.

"Rising sovereign and non-financial corporate leverage is a global phenomenon. Debt levels of non-financial corporates have risen above the pre-crisis levels after a period of decline," Blackrock notes in a recent research report. "And smaller financial sector balance sheets have reduced liquidity in credit markets."

"The silver lining: Lower interest rates make the cost of servicing this debt much cheaper than a decade ago, and maturities have been lengthened, providing resilience to rising rates," the report added.

The increasing size of bond auctions from the Treasury, which is tasked with raising cash to fund the government's ballooning deficit triggered by last year's $1.5 trillion tax reform bill, is a third.

The ongoing reduction of the Federal Reserve's balance sheet, which includes $2.13 trillion in Treasury bonds across all maturities, will also weigh on the market in the coming months.

America's August budget deficit nearly doubled from the same period last year, the Treasury said yesterday, to $214 billion, taking the fiscal year total (October to September) to just under $900 billion, a 24.2% increase from the prior period.

The Treasury issued $1.079 trillion in new bonds, T-Bills and notes last month, the highest of the year, taking the 2018 gross total to $10.675 trillion, a figure that translates (once maturing bonds are subtracted) to a net cash increase of $1.206 trillion.