As traders abandoned their bets on further interest rate hikes by the Federal Reserve, market attention turned to fears that the Iranian conflict could exacerbate an economic slowdown, prompting a sharp rebound in the U.S. Treasury market from its most severe sell-off in 17 months. Federal Reserve Chair Jerome Powell, speaking at Harvard University, stated that the central bank is largely powerless to address supply-side shocks, such as the surge in oil prices triggered by the U.S.-Iran conflict. This remark alleviated market concerns that the Fed would be forced to tighten monetary policy to curb inflation, leading traders to begin pricing in the possibility of rate cuts within the year. The abrupt shift in market sentiment pushed short-term Treasury yields down by more than 10 basis points at one point, before the losses narrowed, allowing the Treasury market to recover from its steepest monthly decline since October 2024.
The rebound reflects growing concerns that escalating conflict in the Middle East will impact an already slowing U.S. economy, where job growth is moderating, and rising fuel prices are driving up costs for businesses and consumers. John Briggs, head of U.S. interest rate strategy at Natixis, noted that before last Friday, investors appeared more worried about the inflationary shock from rising oil prices and began pricing in Fed rate hikes, but since then, the market’s focus has shifted to growth concerns. Gennadiy Goldberg, head of U.S. rates strategy at TD Securities (TD), pointed out that the market is uncertain about how to respond to recent geopolitical events—whether to focus on inflation shocks or growth shocks. Early last week, futures markets had fully priced in one rate hike by the end of the year, but by Monday, traders had priced in a 20% chance of a rate cut before the December meeting.
The rebound in U.S. Treasuries drove a synchronous recovery in global bond markets, with yields on Japanese, British, and German government bonds all falling. The U.S. two-year Treasury yield dropped 9 basis points to 3.82%, while the ten-year yield fell about 9 basis points to 4.34%. Major U.S. bond funds, including Pacific Investment Management Company (PIMCO), had previously warned that financial markets were underestimating the risk of an economic slowdown. The conflict, now in its fifth week, shows little sign of ending, with a key crude oil benchmark still hovering above $110 per barrel. Ian Lyngen, head of U.S. rates strategy at BMO Capital Markets (BMO), summarized that the Treasury market rebounded on Monday as investors focused on the potential global growth risks associated with events in the Middle East, rather than continuing to trade the conflict solely from the perspective of an inflation shock.
