US Treasury yields have reached 4.47% on 10-year notes, rising from 3.95% before the Iran war began at the end of February. According to Reuters, the benchmark yield initially rose to an intraday high of 4.518% before retreating from session highs, as investors weighed conflicting signals surrounding diplomatic efforts between the United States and Iran. The surge reflects growing unease among investors about lending money to the Trump administration, with the energy price spike triggered by the Iran war seeping into government bond pricing. The yield increase is creating affordability pressures that are hampering economic growth and creating new risks for Republicans ahead of November's mid-term elections. Strong economic data has prompted traders to abandon expectations of Federal Reserve rate cuts this year, with markets briefly pricing in the possibility of a rate increase before year-end.
Despite geopolitical uncertainties, US economic indicators provided strong support for bond yields, with manufacturing PMI rising to 54.0 in May, the highest reading since May 2022 and exceeding economists' expectations of 53.0. As reported by Reuters, the Commerce Department also reported that construction spending increased 0.4% in April, surpassing forecasts for a 0.2% gain. The two-year Treasury yield rose 3.7 basis points to 4.051%, reaching its highest level since May 22, while the spread between two-year and 10-year Treasury yields stood at a positive 42 basis points. These positive economic readings helped offset some of the geopolitical concerns that initially drove yields higher.
Persistent strength in crude oil prices, compounded by the closure of the Strait of Hormuz, has prompted investors to reassess Federal Reserve policy expectations significantly. According to Reuters citing CME FedWatch data, markets are now pricing in a 53.4% probability of at least one 25-basis-point Federal Reserve rate increase by December, up from roughly 45% in the previous session. This represents a dramatic shift from the start of the year when investors had anticipated around two rate cuts during 2026. The combination of elevated energy prices, resilient economic activity and uncertainty surrounding Middle East diplomacy continues to shape investor expectations for inflation and the future path of Federal Reserve policy.
Inflation expectations have edged higher as geopolitical developments and energy price pressures create new inflationary concerns. The five-year Treasury Inflation-Protected Securities (TIPS) breakeven rate rose to 2.55% from 2.53% on Friday, while the 10-year TIPS breakeven rate stood at 2.413%, suggesting investors expect inflation to average approximately 2.4% annually over the next decade. The persistent strength in crude oil prices, compounded by the closure of the Strait of Hormuz, has prompted investors to reassess the outlook for US interest rates. The prolonged energy disruption is creating significant economic consequences beyond oil prices alone, with mortgage rates remaining above 6.6% due to rising Treasury yields, while corporate refinancing becomes more expensive and credit conditions tighten.
