Yellen reaches an agreement, U.S. Treasury bonds rise across the board, and traders reduce bets on Fed rate hikes.

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The United States and Iran have reached a temporary agreement to reopen the Strait of Hormuz, triggering a broad rebound in global bond markets. Traders immediately cut their bets on a Fed rate hike this year, Brent crude prices continued to decline, and inflation expectations cooled as a result.

Swap market data shows the probability of the Fed raising rates by 25 basis points before December has dropped from about 80% last Friday to about 70%. Yields on U.S. Treasuries of all maturities fell across the board, with short-term yields—most sensitive to monetary policy—leading the declines: the 2-year yield fell by as much as 7 basis points to 4.01%, while the 10-year yield dropped 6 basis points to 4.42%.

The drop in oil prices directly eased market concerns about further inflation. The decline in U.S. Treasury yields simultaneously affected sectors like corporate debt and emerging market assets. Bond markets in Europe and Asia also rebounded, and the dollar fell directly linked to the fading of risk-off demand.

Fabio Bassi, cross-asset strategy director at JPMorgan, said:

"Investors believe falling oil prices will reduce the need for developed market central banks to take more aggressive rate hikes, but market participants are used to the impact of volatile news from the Middle East, so they remain somewhat skeptical about the current situation."

Yields drop across the board, short squeeze emerges

The decline in U.S. Treasury yields is evident at all curve points. The 2-year yield fell as much as 7 basis points to 4.01%, and the 30-year yield dropped 5 basis points to 4.92%, hitting its lowest since May 7.

Tomo Kinoshita, global market strategist at Invesco Asset Management Japan, pointed out that, based on historical postwar correlations, every 10% drop in oil prices leads to a roughly 13 basis point decline in the U.S. 10-year Treasury yield.

Matthew Haupt, hedge fund manager at Wilson Asset Management, commented: "Some rate debt short positions will be unwound. Central banks can now be less hawkish, as they can wait and ignore any short-term inflation."

In Europe, bond yields also generally fell, and traders simultaneously lowered expectations for rate hikes by the Bank of England (which meets this Thursday) and the European Central Bank. The ECB had taken the lead last week, raising borrowing costs by 25 basis points, becoming the first major central bank to do so.

Fed decision imminent, Walsh faces easing hike pressure

The Fed will announce its policy decision this Wednesday, the first rate meeting chaired by the new chairman, Walsh.

Economists expect the Federal Open Market Committee to keep the benchmark rate at a range of 3.5%-3.75%, while observing the actual impact of energy price shocks from the Iran war on the economy. Previously, U.S. consumer price increases hit a three-year high, intensifying voices within FOMC in favor of a rate hike.

Leslie Falconio, head of taxable fixed income strategy at UBS Global Wealth Management, said the drop in oil prices is easing the pressure on Walsh to raise rates.

She noted that before the ceasefire news, "the 2-year yield was still rising, because the market was digesting a nearly 100% probability of a rate hike in December 2026"; but as oil prices have fallen, the market is pricing out these rate hike expectations, pushing short-end yields lower.

Falconio expects the FOMC will formally remove its dovish bias and issue more hawkish forward guidance at this week’s meeting, but she also believes the Fed's next move will be a rate cut, likely in the first or second quarter of 2027.

She says holding rates steady will allow policymakers to assess the "still struggling" state of economic growth and subsequent labor market trends. "I think they will use their options, observe, and wait for data before making changes," she said.

Disagreements on interpretation, market enters anxious waiting phase

Despite generally positive market sentiment, uncertainties about the implementation of the agreement cannot be ignored. According to a previous Wallstreet News article, the U.S. and Iran had significant differences regarding strait transit fees, revealing the difficulty of reaching a final agreement on unresolved issues concerning Iran's nuclear program.

Andrew Ticehurst, strategist at Nomura Holdings, said:

"The Strait is expected to reopen on Friday, so there may be a period of anxious waiting between now and then, and Israeli actions during this time could also be a variable."

On the dollar side, the Bloomberg Dollar Index fell to its lowest since June 5 as risk aversion waned, but since the U.S. and Israeli strike on Iran at the end of February, the index is still up about 1.4%; traders last week remained generally optimistic about the dollar.

Looking ahead, Fabio Bassi expects the U.S. 10-year Treasury yield to approach 4.70% by year-end, and believes that a break above this level will offer long-term investors a buying opportunity.

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