Rising oil prices put pressure on market interest rate cut expectations, while U.S. Treasury yields continue to rise

According to Zhitong Finance APP, due to market expectations that rising oil prices will prompt Federal Reserve policymakers to express caution regarding further interest rate cuts at this week's meeting, U.S. Treasury prices fell in response. On Monday, U.S. Treasury prices briefly narrowed their losses, while oil prices also declined. Earlier, media reports indicated that Iran expressed a desire to end the conflict with Israel. Nevertheless, yields on U.S. Treasuries of various maturities still rose by 2 to 6 basis points.

Oil prices remain well above the levels prior to Israel's attacks over the weekend, raising concerns about the risk of persistently high inflation. The yield on the U.S. 2-year Treasury rose slightly by about 2 basis points to 3.97%, as traders reduced bets on the Federal Reserve easing policy, expecting a cut of about 45 basis points by the end of the year, down from last Friday's expectation of 49 basis points.

The bond market is awaiting the start of the Federal Reserve's two-day meeting on Tuesday local time. Although most expect officials to keep interest rates unchanged, the market will still look forward to the quarterly economic and interest rate forecast report—the so-called "dot plot." In March, Federal Reserve officials indicated that there would be two rate cuts this year.

Kevin Flanagan, head of fixed income strategy at WisdomTree, stated, "If we were to predict the outcome of the Federal Reserve meeting, the biggest risk is that the expected two rate cuts could be adjusted to one rate cut, as just one or two committee members changing this expectation could alter the outcome."

After the auction of 20-year U.S. Treasuries, the performance of long-term Treasuries still lagged behind the market, although the yield levels determined by this auction met expectations. This represents a significant improvement compared to last month's auction of this maturity, which was below expectations and triggered widespread selling. Since the Federal Reserve meeting ends on Wednesday local time and the U.S. holiday begins on Thursday, this $13 billion auction was held two days earlier than usual.

Since the tensions between Israel and Iran escalated into direct conflict, U.S. Treasury prices have been on a downward trend—if past conflict events are any indication, this selling pressure is likely to have lasting effects. Data shows that Iran's direct attacks in April 2024 and renewed conflict between the two countries in October caused U.S. Treasury yields to rise sharply and remain elevated for the following 30 days.

Due to the conflict between Israel and Iran over the weekend, oil prices initially surged but then retreated. On Monday, WTI crude oil prices fell by as much as 4.9% at one point, but ultimately closed down about 2.3%.

Ed Al-Hussainy, interest rate strategist at Columbia Threadneedle Investments, stated that the risk of market volatility is a concerning issue. Al-Hussainy noted, "The mechanism at play is that this shock sentiment leads to an increase in implied volatility, which in turn triggers a pullback in demand across both risk assets and interest rate assets."

These circumstances have heightened concerns among U.S. Treasury investors, who worry that Trump's policies may trigger inflation and widen the U.S. budget deficit, prompting traders to demand higher premiums for long-term bondsLast week's highly anticipated 30-year U.S. Treasury bond auction saw stronger-than-expected demand, while the 20-year bond auction was rather lackluster. Its yield of 4.942% was in line with expectations, and non-dealers accounted for 86.6% of the share, slightly higher than recent sales.

Wei Liang Chang, a macro strategist at DBS in Singapore, stated: "The pressure on the U.S. Treasury yield curve may further intensify. Given the more uncertain geopolitical environment, investors may consider increasing military spending in the near future. Additionally, if oil prices remain high, the risk of sustained inflation will also increase."

Cameron Crise, a macro strategist at Bloomberg, added: "This auction has alleviated a potential risk of holding long-dated assets, but it remains unclear whether this will prompt a significant market rally ahead of the Federal Reserve's policy announcement later this week."