(Bloomberg) — A Treasury market selloff stalled as investors, doubtful that the energy crisis will lead the Federal Reserve to raise interest rates, were drawn to the highest yield levels of the year.
Benchmark Treasury yields retreated on Friday after climbing to the highest levels since mid-2025. Two-year yields — most sensitive to the Fed’s policy changes — slid as much as nine basis points to 3.90% after 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 mostly 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,” said Ian Lyngen, head of US rates strategy at BMO Capital Markets.
Longer-maturity yields also pulled back from their highest levels of the year. The 10-year note’s remained nearly two 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.
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 consequent 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.
Friday’s price action signaled the approach of an inflection point at which “the market’s reaction function to incrementally higher oil prices would transition” to steepening the curve, Lyngen said in a report published Friday.
Treasury yields broadly have been rising with oil prices since the US attacked Iran on Feb. 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,” said John Briggs, head of US rates strategy at Natixis. The oil shock from Russia’s full-scale invasion of Ukraine in 2022 contributed to a post-pandemic inflation surge that led the Fed to raise rates by more than five percentage points by mid-2023.
What Bloomberg Strategists say…
“The Treasury yield curve’s next move is more likely to be a steepening, led by a potential reversal in front-end yields that have priced oil-driven inflation more aggressively than the growth and labor market impact from higher energy costs.”
—Michael Ball, Macro Strategist, Markets Live
For the full analysis, click here.
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.
“Markets have turned a full 180, and market participants have gone from asking when the next cut will be, to pricing in hikes in 2026,” said Molly Brooks, a rates strategist at TD Securities.
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, with the stock market closed for Good Friday, which is not a federal holiday. De-centralized bond trading, which observes the holiday when it does not coincide with a major economic data release, will have an abbreviated session for investors to react to it.
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, Citigroup economist Andrew Hollenhorst said in a report.
Auctions of two-, five-, and seven-year securities this week were awarded at higher-than-anticipated yields, representing the average interest rate that investors demanded in exchange to meet the US government’s borrowing need, which totaled $183 billion across the three sales.
It was the worst showing by those three tenors in a month since May 2024, when traders also were reducing bets on interest-rate cuts.
The auctions “are a reminder that fiscal challenges rise with interest rates,” Hollenhorst wrote. “Large deficits are easier to finance when the Fed is expected to cut rates,” and “expectations for defense spending are rising.”
–With assistance from Michael MacKenzie.
(Adds context and yield curve shift and updates yield and price levels.)
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