US Treasury bonds advanced on Tuesday, as signs of diplomatic progress between the United States and Iran toward ending the conflict pushed oil prices lower, dampening market expectations for the Federal Reserve to raise interest rates more than once in the coming year. Yields across Treasury maturities fell by 4 to 6 basis points, with the 2-year note yield dropping to its lowest level since July 20, while the benchmark 10-year yield slid to 4.62%.
Since the US strike on Iran in late February, Treasury yields have largely tracked oil price movements in varying degrees. Rising oil prices have stoked inflationary pressures, strengthening the case for tighter US monetary policy. On Tuesday, WTI crude oil futures fell nearly 6%, touching their lowest level since July 13, following comments from US Treasury Secretary Scott Bessent and Qatari representatives, which suggested the US and Iran were nearing a deal.
"In an environment where the Fed's credibility is under scrutiny, and some Fed officials are growing increasingly impatient with inflation running above the 2% target for five consecutive years, we believe US Treasuries will continue to be driven by oil price dynamics," said Priya Misra, a portfolio manager at J.P. Morgan Asset Management.
Short-term interest rate futures reflected expectations for a Fed rate hike of about 15 basis points in September, implying a more than 50% probability of a 25-basis-point increase. The market fully priced in one rate hike by year-end. Just last week, pricing indicated a 100% chance of two rate hikes.
The US bond market is also weighing the possibility that, regardless of oil prices, a robust US economy may necessitate higher interest rates to curb inflation. Investors are awaiting the July jobs report, due Friday, for clearer signals. Meanwhile, data released Tuesday showed a larger-than-expected decline in June job openings, but the market reaction was muted.
"The drop in oil prices should help temper inflation expectations and support a more stable Fed policy outlook," said Sean Simko, head of fixed income investment management at SEI Investments Corp.
Comments