A selloff in US Treasuries resumed on Monday, with the two-year bond yield rising five basis points to 4.90% and the 10-year yield climbing four basis points to 5.20%. This occurred as Brent crude oil gained almost 2% to $106.31 a barrel after President Trump rejected Iran’s latest offer to reopen the Strait of Hormuz. The rejection heightened geopolitical tensions and reinforced expectations of constrained oil supply, which contributes to inflation concerns.
The rise in oil prices is a key driver for markets, as elevated energy costs fuel inflation pressures and support the expectation of additional interest rate increases from the Federal Reserve. According to Damien McColough, head of fixed income research at Westpac Banking Corp., "The ongoing hawkish Fed messaging and oil above $100 are pivotal to the bearish impetus." Swap markets are currently pricing in at least three more interest-rate hikes from the Fed next year, with the possibility of a fourth.
The bond market is also showing signs that a series of Fed rate increases could lead to an economic slowdown. The extra yield investors demand for 10-year Treasuries over two-year notes narrowed to just 17 basis points last week, the smallest gap since early 2025. This flattening of the yield curve increases the likelihood of an inversion, where shorter-term yields surpass longer-term yields, a phenomenon often seen as a precursor to a recession.
Treasury Secretary Scott Bessent, however, has urged Fed policymakers to maintain an "open mind" on interest rates. He argues that potential productivity gains from artificial intelligence and deregulation could help to keep US inflation in check, offering a counter-perspective to the prevailing hawkish sentiment. Nevertheless, until key economic data like PCE, ISM, and payrolls are released later in the week, Middle East gridlock is expected to remain the market's primary focus.
