Powell's remarks cause a 180-degree reversal in market interest rate expectations

As traders sold off positions betting that the Federal Reserve would raise interest rates, the U.S. Treasury market rebounded on Monday, March 30, from its worst selloff in 17 months, as attention shifted to speculation that a U.S.-Iran war could worsen the global economic slowdown.

On Monday, Federal Reserve Chair Jerome Powell said that, against the backdrop of an energy shock triggered by the U.S. and Israel’s war against Iran, the Federal Reserve was inclined to keep rates unchanged and, for the time being, to “ignore” the impact of that shock. The remarks drove further gains in the bond market. Many in the industry noted that Powell’s comments—made during a speech at Harvard University—eased market concerns that the Fed would be forced to tighten monetary policy to curb a rapid acceleration in inflation, prompting traders to restart pricing in a small possibility of rate cuts this year.

The shift in stance briefly pushed short-term U.S. Treasury yields down by more than 10 basis points intraday, before the losses narrowed somewhat. Into the close of the New York session, Treasury yields fell across the board: the 2-year Treasury yield fell 8.19 basis points to 3.830%, the 5-year yield fell 8.21 basis points to 3.986%, the 10-year yield fell 7.76 basis points to 4.350%, and the 30-year yield fell 5.35 basis points to 4.913%.

Worth noting is that Monday’s rebound in Treasury prices also marked the second straight day that yields fell alongside an increase in oil prices. This contrasted with most of March—at the time, Treasury yields climbed as energy prices surged, as the market worried the U.S.-Iran war could drive inflation higher.

The market shifts from worrying about inflation to worrying about the economy

In response, analysts said the latest rebound in the bond market reflects rising anxiety that the conflict erupting in the Middle East will hurt the U.S. economy. With fuel prices rising and lifting costs for businesses and consumers, U.S. job growth has already slowed.

“Before last Friday, investors seemed to be focusing more on the inflation impact brought by the rise in oil prices, so they began factoring in rate-hike expectations into prices, lifting Treasury yields,” John Briggs, head of U.S. rates strategy at Banque de Commerce Extérieure de France, said. “Then, market sentiment shifted. Even though oil prices rose, the focus of concern had moved to economic growth.”

This is a major change for the bond market. Previously, worries about an inflation shock—one that would effectively tie the central bank’s hands—had, to a large extent, overshadowed concerns about economic growth.

Gennadiy Goldberg, head of U.S. rates strategy at TD Securities, said, “The market is unsure how to respond to recent geopolitical events—whether to focus on the first-order inflation impact or the second-order impact on economic growth.” Not only is the geopolitical situation full of uncertainty, but the market is even more undecided about how the Fed will respond to these developments.

As shown in the chart below, in early last week, the futures market priced in rate hikes by year-end as a virtual certainty, and even as late as last Friday it still believed this was highly likely to happen. However on Monday, sentiment shifted dramatically, to the point where traders briefly thought the likelihood of rate cuts by year-end had reached 20%.

Recession risk cannot be ignored

Large parts of the U.S. bond-fund universe, including Pacific Investment Management Company (PIMCO), had previously warned that as inflation concerns intensified, financial markets were underestimating the risk of economic slowdown. Goldman Sachs also said the probability of a U.S. recession in the coming year had risen to roughly 30%.

At present, the U.S.-Iran conflict has entered its fifth week. Even after the United States extended its deadline for Iran to agree to reopen the Strait of Hormuz, there have still been no signs that the standoff is ending. This has led the international benchmark Brent crude price to hover above $110 per barrel on Monday, while U.S. WTI crude also rose above the $100 mark, for the first time since 2022.

Although Trump previously posted on social media that the U.S. government is conducting “serious talks” with the Iranian regime, he also reiterated the threat that if no agreement is reached, the U.S. would strike Iranian oil and power infrastructure. Iran has said that the peace talks have made no progress and has hinted that it has the capability to continue fighting for longer, increasing the risk that the conflict becomes prolonged, which in turn could cut off key energy supplies to much of the world.

Jim Barnes, head of fixed income at Bryn Mawr Trust, said the conflict situation does not appear to be improving much. “Investors originally thought that since the war has gone on this long, we should be closer to the end, but reality is not like that. This causes investors to reexamine things, or to incorporate a long-term perspective into their thinking. Given the current situation, it is this factor that is weighing down yields.”

“On Monday morning, the U.S. Treasury market rose because investors were focusing on the potential risks that the situation in the Middle East poses to global economic growth, rather than trading this conflict solely from the perspective of an inflation shock,” said Ian Lyngen, head of U.S. rates strategy at BMO Capital Markets.

Evercore ISI fixed income strategist Stan Shipley said, “Over the past two months, the U.S. Treasury market has been too narrowly focused on inflation. Now, people are starting to worry that if oil prices rise enough, the economy will fall into recession. That’s good news for the Treasury market.”

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责任编辑：郭建