US Treasury bonds advanced across the board after news of a provisional agreement with Iran led investors to scale back their expectations for Federal Reserve interest rate hikes.
Yields on Treasuries of all maturities declined, with yields on short-term bonds—the most sensitive to monetary policy shifts—leading the drop. Swap market traders now see roughly a 70% chance of a 25-basis-point Fed hike by December, down from approximately 80% last Friday. Brent crude oil prices fell about 5%, easing inflation concerns. The US dollar weakened.
The rise in US bond prices stemmed from investor optimism that a resolution to the Iran conflict would help reopen the Strait of Hormuz and lower oil prices. The implications of this move extend far beyond the $31 trillion US Treasury market, given that US debt serves as the benchmark for global borrowing costs, influencing everything from corporate bonds to emerging market assets. The dollar's decline is linked to a reduction in safe-haven demand.
"Investors believe lower oil prices will reduce the need for developed-market central banks to adopt more aggressive rate hikes," said Fabio Bassi, Head of Cross-Asset Strategy at JPMorgan Chase. "Market participants have grown accustomed to the back-and-forth of news from the Middle East, so a degree of skepticism about the current situation remains."
Bassi anticipates the 10-year US Treasury yield will be near 4.70% by year-end. He suggests that if yields rise above that level, it could present a buying opportunity for long-term investors.
The yield on the 2-year Treasury note fell as much as 7 basis points to 4.01%, while the benchmark 10-year yield dropped 6 basis points to 4.42%. The 30-year yield declined up to 5 basis points to 4.92%, its lowest level since May 7th.
"Some short positions in interest rates will be unwound," said Matthew Haupt, Portfolio Manager at Wilson Asset Management. "Central banks can now be less hawkish because they can wait and ignore any short-term inflation."
The US and Iran stated they have reached an agreement to reopen the Strait of Hormuz. This would provide relief for the US, where consumer price increases have been the fastest in three years, and investors are focusing on new Fed Chair Kevin Warsh and his policies.
The Fed is set to announce its policy decision this week, with economists expecting the central bank to hold its benchmark rate steady in the 3.5%-3.75% range while it assesses how the energy price shock from the Iran war will impact the economy.
"Based on correlations observed post-war, in the bond market, a 10% drop in oil prices would lead to about a 13-basis-point decline in the US 10-year Treasury yield," said Tomo Kinoshita, Global Market Strategist at Invesco Asset Management Japan.
Bond yields broadly fell across Europe as traders pared back expectations for rate hikes from the Bank of England—which is scheduled to meet on Thursday—and the European Central Bank. The ECB raised borrowing costs by 25 basis points last week, becoming the first major central bank to do so. Asian bond markets also rebounded.
Anxious Wait
Meanwhile, as markets grew optimistic about a deal to end the war, demand for safe-haven assets waned, pushing the US dollar exchange rate to its weakest point since June 5th. However, the Bloomberg Dollar Spot Index is still up about 1.4% since US and Israeli strikes on Iran in late February, and traders' overall stance on the dollar remained positive last week.
Just minutes after the agreement was announced, the US and Iran offered differing interpretations—highlighting how difficult it will be to reach a consensus on outstanding issues regarding Iran's nuclear program.
"The strait is expected to reopen on Friday, so there could be an anxious waiting period from now until then," said Andrew Ticehurst, a strategist at Nomura Holdings. "Israel's actions during this period could also be a variable."
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