U.S. Treasury prices declined, with the 30-year yield reaching its highest level since July. As oil prices surged, traders increased their bets on the Federal Reserve raising interest rates.
On Monday, yields across the curve rose by at least 7 basis points, with the 30-year yield climbing to 5.03%. The two-year yield, which is highly sensitive to Federal Reserve policy expectations, increased by as much as 11 basis points to 3.99%.
Interest rate swaps indicate that traders now see an approximately 80% probability of a Fed rate hike by the end of April 2027. This contrasts sharply with expectations prevailing in late February, before the outbreak of the Iran conflict, when markets were anticipating a series of interest rate cuts.
Brent crude prices rose sharply on Monday following renewed attacks on critical energy infrastructure and tankers in the Middle East. Elevated crude oil prices have become a primary driver of global bond yield movements, altering the inflation outlook and prompting traders to abandon predictions of Fed rate cuts this year.
Barclays economists adjusted their interest rate forecast for the Fed on Monday. Citing the energy price outlook, they now anticipate only one rate cut by the end of next year, projected for March 2027. Previously, the firm had also expected a cut in September 2026. Morgan Stanley economists made a similar adjustment last week.
Andrew Szczurowski, a portfolio manager at Morgan Stanley Investment Management, stated, "Looking at bond market pricing, concerns about inflation and the duration of the conflict have increased."
Significant capital flows were observed in the SOFR options market on Monday, including downside hedges related to expectations for further Fed rate hikes before year-end.
Beyond monitoring the Middle East situation, bond traders are also awaiting the U.S. government's quarterly financing plan, due on Wednesday. This plan typically provides guidance on the size of Treasury auctions through July.
Traders will also closely watch key employment data scheduled for release on Friday. Economists expect the unemployment rate to hold at 4.3% for April, while job growth is projected to slow.
Szczurowski mentioned that he has increased allocations to short-term Treasuries. He believes the labor market will cool in the coming months, allowing the Fed to resume accommodative policies. However, given an uncertain fiscal outlook, he remains cautious about long-term bonds. He said, "I don't believe the Fed will cut rates in the next few months, or even a quarter or two, but it hasn't completely ruled out the possibility of cuts either."
Nohshad Shah, Head of EMEA Fixed Income Sales at Citadel Securities, expressed his view that the Iran conflict will likely subside, which would support bond and equity markets in the near term. However, he noted in a client report that the risk remains that, with economic growth still "robust," rising oil prices could drive broader inflation and inflation expectations—a scenario that central banks and markets may be underestimating. He wrote, "Upcoming jobs data will reveal whether the shift in economic conditions is sufficient to justify a more hawkish policy pivot, which, if realized, could adversely impact risk assets."
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