MW A war-weary Treasury market faces a fresh test with Friday's jobs report
By Isabel Wang
Investors are demanding more compensation in the Treasury market because of uncertainty, not just higher oil prices
Treasury yields could stay higher, even if oil prices fall.
Oil prices and Treasury yields have lurched higher in tandem over the past three months. Now the new worry on Wall Street is that investors are simply losing patience and demanding higher compensation to lend money to the government.
At first blush, that might sound like a win for investors, since higher yields tend to mean better returns. But higher Treasury rates also can set off a vicious cycle where a growing share of the revenue generated by the U.S. economy is absorbed by interest payments. The same goes for U.S. households and major companies, which pay a spread above benchmark Treasury rates to borrow.
Another big concern is that the roaring bull market in stocks could hit a wall if borrowing costs stay higher for longer. The S&P 500 SPX was up almost 27% from a year ago on Wednesday.
One way to gauge how much those pressures could worsen is to monitor where the bond market expects inflation to go next. Right now, despite the oil shock driving the national average for gas prices to $4.26 a gallon, bond investors are betting the inflation bump won't last.
A key gauge of expectations of where consumer prices are headed on Wall Street - the 10-year break-even inflation rate - has barely budged since the U.S. and Israel attacked Iran in late February. The break-even rate, in this case, represents where the bond market thinks the inflation rate will be in a decade.
Currently at 2.39%, it has only risen about 10 basis points since February, according to this chart from the Federal Reserve Bank of St. Louis.
SOURCE: Federal Reserve Bank of St. Louis via FRED
"Long-run inflation expectations remain well anchored," said Lawrence Gillum, chief fixed-income strategist at LPL Financial. "Market-implied break-evens have not broken out to levels that would signal a loss of confidence in the Fed's 2% target."
Yet Treasury yields have surged. The 10-year yield BX:TMUBMUSD10Y went up by as much as 70 basis points after the start of the Iran war, before easing back a bit. Last month, it hit its highest level since January 2025 and inched uncomfortably close to 5%, according to FactSet data.
Those levels have rarely been sustained in the era of low rates and tame inflation that followed the global financial crisis.
It's unclear how sensitive the new economy that grew out of that era is to higher rates and inflation running close to 4%.
That makes Friday's government jobs report the next big test for Treasury yields, inflation expectations and the direction of longer-duration yields. The report is expected to give investors a snapshot of the economy last month as yields rose and inflation climbed. Any surprises could jolt the bond market.
See: The economy is creating more jobs, but these groups are having trouble finding work
The bond-market narrative lately has been focused on "growth and labor-market re-acceleration," said Garrett Melson, portfolio strategist at Natixis Investment Managers Solutions. Recent data, however, only shows "stabilization," he said, pointing to decelerating wage growth, eroding real incomes and ongoing inflation pressures as factors likely to weigh on growth and drive Treasury yields lower.
"I do think there's scope for markets to be somewhat disappointed by labor-market data on Friday," Melson said.
On the other hand, problematic inflation and a stabilizing labor market are expected to result in the Fed holding rates steady next month. Eventually, that combination could pave the wave for rate hikes. But any loss of confidence in the Fed's commitment to fighting inflation could panic the Treasury market.
Unlike 2022, when inflation expectations rose in tandem with actual inflation, the divergence this year between the two may underscore changes in growth expectations rather than a pure inflation story, said Gillum at LPL Financial.
The bond market may now be pricing in a "soft landing plus" scenario, he said. In that backdrop, the economy may remain resilient but 10-year Treasury yields likely stay elevated, even if the Iran war ends and oil prices retreat.
"That said, we really haven't seen the full effects of the higher oil prices yet either, so that takes a little time to articulate throughout the economy," Gillum said. "But the longer these gas prices stay elevated, the higher potential for an economic slowdown."
-Isabel Wang
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(END) Dow Jones Newswires
June 04, 2026 12:46 ET (16:46 GMT)
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