US yields rise for second straight session as oil rally continues

NEW YORK – US Treasury yields rose for a second straight session on Tuesday but eased from earlier highs, as the Iran war entered a fourth day and continued to push oil prices higher and fan inflation worries.

Israeli and US forces hit targets across Iran, leading to Iranian retaliatory strikes around the Gulf as the conflict spread to Lebanon and sparking concerns of an extended upheaval to global energy supplies.

A day after President Donald Trump and Prime Minister Benjamin Netanyahu gave open-ended answers when asked how long the war would last, a source told Reuters that Israel’s campaign had been planned to last two weeks and was moving faster than expected.

US crude rose 4.9% to USD 74.72 a barrel and Brent jumped to USD 81.44 per barrel, up 4.76% on the day, after hitting a 19-month high of USD 85.12. Crude had settled up more than 6% on Monday.

“If oil prices remain elevated for a prolonged period, the resulting inflationary pressures could prove detrimental to the global economy and may constrain the Federal Reserve from cutting rates, and in a more adverse scenario, could even open the door to rate hikes,” said Phil Blancato, chief market strategist at Osaic in New York.

“The conflict’s duration and the potential for further US involvement and resources remain uncertain. Fixed income yields could remain elevated in response to inflationary concerns, though a recessionary scenario appears unlikely at this stage.”

The yield on the benchmark US 10-year Treasury note edged up 0.4 basis point to 4.056% after climbing to a 2-1/2-week high of 4.117% on the day.

Rising inflation fears have dented expectations for a rate cut from the Federal Reserve. Markets were initially targeting the central bank’s June meeting as the first with more than a 50% chance for a cut of at least 25 basis points, but the probability has now dropped to 39.1%, according to CME’s FedWatch Tool.

The yield on the 30-year bond added 0.3 basis point at 4.702% after rising to 4.746%, its highest since February 20.

New York Federal Reserve President John Williams said it is too soon to gauge the impact of the war with Iran on US inflation and growth, but the American economy is far less dependent on imported oil than it has been and has proved resilient to energy price shocks.

Federal Reserve Bank of Minneapolis President Neel Kashkari said the conflict has raised uncertainty about the US economic outlook and made the outlook for monetary policy less clear.

A closely watched part of the US Treasury yield curve measuring the gap between yields on two- and 10-year Treasury notes, seen as an indicator of economic expectations, was at a positive 55.4 basis points after earlier dropping to 50.3, its narrowest since November 28.

The two-year US Treasury yield, which typically moves in step with interest rate expectations for the Fed, advanced 1.3 basis points to 3.5% after advancing to 3.599%, its highest since late January.

Kansas City Federal Reserve President Jeffrey Schmid signaled his continued opposition to further interest-rate cuts, saying the US labor market is in balance and inflation is too hot, although he also did not address the potential impact of the conflict in Iran.

The breakeven rate on five-year US Treasury Inflation-Protected Securities (TIPS) was last at 2.515% after closing at 2.499% on Monday, its highest since February 11.

The 10-year TIPS breakeven rate was last at 2.281%, indicating the market sees inflation averaging about 2.3% a year for the next decade.

(Reporting by Chuck Mikolajczak, additional reporting by Laura Matthews; Editing by Andrea Ricci and Nia Williams)