Treasury yields climb as bonds sell off and fear grows that Fed rate cuts are off the table

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Markets face prolonged conflict risk as energy drives inflation fears

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Treasury yields jumped on Friday as investors began to fear that the Federal Reserve may not lower interest rates at all this year, as the war in the Middle East threatens to drive inflation higher.

The 10-year Treasury yield — the benchmark for U.S. government borrowing — added nearly 11 basis points to 4.39%. The 2-year note yield — more sensitive to short-term Fed rate decisions — traded at 3.89%, up nearly 6 basis points. Even the 30-year bond yield rose almost 11 basis points, to 4.96%.

One basis point equals 0.01%, or 1/100th of 1%, and yields and prices move inversely to one another.

The sell-off in bonds came after Iran and Israel exchanged strikes overnight, with Iran launching new attacks against energy sites in Kuwait and elsewhere in the Persian Gulf. The Wall Street Journal reported, citing U.S. officials, that the Pentagon is sending thousands of additional Marines to the Middle East, while CBS News said that “heavy preparations” were being made for sending ground troops to Iran, citing multiple sources.

With no end in sight to the escalation, investors are positioning for a more hawkish stance from the Fed as higher global oil prices reshape the economic backdrop.

“The backdrop domestically is less friendly than it was a couple weeks ago too, because the Fed has kind of reversed course. The market has removed basically every rate cut from this year, and now is pricing odds of a hike,” Baird investment strategist Ross Mayfield said to CNBC.

Mayfield referred to the fact interest rate futures traders are now pricing in almost a 1-in-5 chance of a rate hike in June, and no chance of a rate cut, based on probabilities calculated in the CME FedWatch tool.

Inflation was already trending above the Fed’s target even before energy costs spiked at the outbreak of the Iran war on Feb. 28. The Fed’s rate-setting Federal Open Market Committee voted 11-1 on Wednesday to leave its key interest rate unchanged at the current 3.50% to 3.75%.

Central banks in Europe also held rates steady this week as policymakers grappled with the impact of the war, with markets increasingly pricing in rate increases this year in order to contain higher prices.

— CNBC’s Spencer Kimball contributed to this report.

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