Treasury Market Selloff Stalls as Investors Ditch Interest Rate Hike Fears

Benchmark Treasury yields retreated on Friday, following a selloff, as investors grew less concerned that the energy crisis would lead to higher interest rates from the Federal Reserve. The benchmark two-year yield, most sensitive to the Fed's policy changes, slid as much as 9 basis points to 3.90%, erasing an increase to nearly 4.03%, the highest level since June.

The bond market recovered even as crude oil hit new multiyear highs, breaking from its recent pattern. Investors have largely brushed aside the drag of higher fuel costs over the past month, instead pushing yields higher in anticipation of higher inflation. The front-end of the Treasury yield curve has shifted away from following energy prices as an inflationary risk, and is now more focused on the downside for growth and risk assets.

Longer-maturity yields also pulled back from their highest levels of the year. The 10-year note remained nearly 2 basis points higher on the day at 4.43% after topping 4.48% for the first time since July. Yields reached session highs as oil prices extended the advance unleashed by the US war on Iran, which is entering its fifth week.

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Short-term Treasury yields remained near their lowest levels of the day even as the US benchmark West Texas Intermediate crude oil futures contract settled at $99.64 per barrel, the highest level since mid-2022. Global benchmark Brent crude also closed at a multiyear high.

The steepening of the yield curve marked a break with the past month's pattern, in which oil price increases have been associated with yield-curve flattening as investors anticipated the Fed responding to higher inflation. The market's reaction function to incrementally higher oil prices would transition to steepening the curve.

Treasury yields have been rising with oil prices since the US attacked Iran on February 28, disrupting supply from the region. Yields and oil prices briefly slumped late Thursday after US President Donald Trump extended a 10-day pause on strikes against Iranian energy sites, even as he cast doubt on the possibility of reaching a peace deal.

Higher yields reflect the potential for the related increase in US retail gasoline prices to show up in broad measures of consumer inflation, deterring the Fed from delivering interest-rate cuts that were widely expected before the outbreak of hostilities. As long as the Strait of Hormuz remains closed, investors will fear "inflation and a 2022-style response from central banks."

Read also: US-Iran Tensions Spark Uptick in Oil Prices Amid Global Market Decline

Market-based inflation expectations for the coming year, though off last week's highs, have surged past 3% from about 2.2% at the start of the year. Swap contracts whose rates represent expectations for future Fed rate decisions no longer signal any chance of a cut this year and price in a more than 50% chance of a hike.

The Fed cut rates three times last year in response to a weakening jobs market. While those concerns have largely abated, February's employment data was weaker than economists estimated. The March jobs report is scheduled for release under unusual market conditions next week on April 3.

Friday's price action kept the US Treasury market on track for one of its worst months in the past five years. As measured by the Bloomberg Treasury index, the US government bond market had a loss of 2.36% this month through March 26. The monthly decline would be the biggest since October 2024. Upward pressure on Treasury yields also stems from the prospect of increased borrowing by the US government, both to cover war costs and to refinance existing debt at higher interest rates.