US Treasuries slide as Middle East conflict sparks oil price surge – are inflation fears reducing hopes for Fed rate cuts?

10-year Treasury yield today: For bond investors, this week’s Middle East escalation has created an uncomfortable dilemma.

US Treasuries Slide as Middle East Conflict Fuels Inflation Fears

In moments of global tension, US Treasuries are usually the first place traders run for safety. But as oil prices surge on fears of a widening conflict, including the effective closure of the Strait of Hormuz, the usual playbook isn’t working.

Instead of piling into government debt, traders are worrying about inflation.

Oil Price Surge Clouds Federal Reserve Rate Cut Outlook

Higher oil prices are stoking fears that price pressures could accelerate again, potentially forcing the Federal Reserve to slow or scale back its plans for interest-rate cuts, as per a report. US President Donald Trump has said the bombing campaign could continue for weeks, adding to the uncertainty hanging over markets, as per a Bloomberg report.

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Treasury Yields Jump as Rate Cut Expectations Shift

The reaction was swift. Two-year Treasury yields jumped six basis points to 3.44%, while 10-year yields climbed five basis points to 3.99%. Money markets pushed back expectations for the next Fed rate cut by two months, now looking toward September.

Charu Chanana, investment strategist at Saxo Markets said that, “The ‘bond-as-haven’ trade becomes less clean,” if higher oil prices keep price-growth pressures elevated, as quoted by Bloomberg.

European Bonds Fall and Inflation Gauges Surge

The pressure wasn’t limited to the US. European government bonds also fell, while market gauges of inflation rose sharply. Euro-denominated one-year inflation swaps jumped as much as 11 basis points, and breakeven rates climbed.

Historical Data Shows Oil Shocks Can Lift Bond Yields

History offers context. A Deutsche Bank analysis of major geopolitical events over the past 30 years, from Iraq’s invasion of Kuwait to the September 11 attacks and Russia’s invasion of Ukraine, found that higher oil prices can significantly lift bond yields, as per the Bloomberg report.

A separate Societe Generale study of five oil supply shocks over the past 50 years showed that 10-year Treasuries typically weakened in the weeks and months that followed.

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Rising Government Borrowing Adds Another Layer of Risk

There’s also the question of government borrowing. Extended military operations or efforts to shield households and businesses from rising energy costs could increase bond supply.

Portfolio manager of Fidelity International, Mike Riddell added to positions that would benefit if long-dated Treasuries sell off, arguing that, “It’s been a trend for a while for governments around the world to subsidize energy and food prices,” adding “This trend will only accelerate if the Middle East crisis persists or escalates, which makes long end sovereign bond yields vulnerable at current levels," as quoted by Bloomberg.

February Treasury Rally Reverses

The selloff comes after a strong February rally in Treasuries, when faltering US-Iran talks and concerns over artificial intelligence helped push the 10-year yield below 4% for the first time since November. Two-year yields had dropped to their lowest level since August 2022.

Haven Demand Could Return If Growth Slows

Some investors believe the haven trade could return if economic damage becomes clearer. John Taylor of AllianceBernstein said that if higher oil prices persist and begin weighing on growth, that could eventually push Treasury yields lower, as per the report.

Markets Caught Between Inflation and Economic Slowdown

For now, though, the bond market is wrestling with competing fears: inflation versus slowdown. Iran’s security chief has said the nation has no intention of negotiating with the US, and missile interceptions across Bahrain, Kuwait, the United Arab Emirates and Qatar underscore how the conflict is spreading.

Money markets have trimmed bets on three Fed rate cuts this year but still broadly expect reductions by the end of 2027. And while some traders are cautious, others are positioning for safety. Franklin Templeton’s Andrew Canobi added to Treasury holdings via futures, saying that if the situation escalates, markets could shift toward a classic downside scenario, as per the Bloomberg report.

FAQs

Why are US Treasuries falling despite global tensions?

Investors are worried that rising oil prices could push inflation higher, reducing the likelihood of aggressive Fed rate cuts.

How much did Treasury yields rise?

The two-year yield climbed to 3.44%, and the 10-year yield rose to 3.99%.