Yields Increase amid Rising Oil Prices as Fed Weighs Inflationary Pressures Against Growth Concerns

Middle East Conflict and Tariffs Fuel Inflation Concerns as Oil Prices Rise

U.S. Treasury yields rose on Thursday, as climbing oil prices kept inflation fears elevated, leaving traders and Federal Reserve policymakers to navigate the competing risks of stubbornly high price growth and a slowing economy. War-driven disruptions in the Middle East have pushed oil prices higher, while trade tariffs have added to cost pressures, stoking concerns about a renewed bout of inflation as price growth remains above the Fed's 2% annual target.

The labor market, however, has shown stability, with weekly jobless claims falling last week, suggesting the labor market remains on relatively stable footing. Despite this, a softening labor market could push the Federal Reserve toward a more accommodative stance. The Federal Reserve is now facing a complex decision on whether to ease policy in the face of inflation concerns.

The market is trying to figure out whether inflation or growth is what matters, and what the Fed does next. The Fed's justification for not doing much in the very near term is understandable. Fed funds futures traders are now pricing in less than 50% odds of a 25-basis-point cut by year-end, a sharp reversal from earlier expectations of two cuts by year-end.

| Fed Funds Futures Expectations | Current | Previous | | --- | --- | --- | | Odds of 25-basis-point cut by year-end | Less than 50% | 2 cuts by year-end | | Period of rate hikes following war | Briefly priced in | - |

The 2-year note yield, which typically moves in step with Fed interest rate expectations, rose 1.2 basis points to 3.778%. It has fallen from a nine-month high of 4.027% on March 27 on optimism over a ceasefire in the Iran war. Benchmark 10-year yields rose 3 basis points to 4.309%. They reached an eight-month high of 4.484% on March 27.

A closely watched part of the U.S. 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 52.9 basis points. U.S. President Donald Trump announced on Thursday that Lebanon and Israel had agreed to a 10-day ceasefire and said the next meeting between the United States and Iran may take place over the weekend, adding to optimism that the Iran war may be nearing an end.

New York Fed President John Williams said on Thursday that the Middle East conflict is already stoking inflationary pressures, while noting the central bank is well-positioned to respond to whatever economic conditions may emerge. Traders are also watching whether Kevin Warsh, Trump's nominee to lead the Fed, will be confirmed by the Senate as he faces a confirmation hearing on April 21.

Analysts at Wells Fargo warned that market volatility could pick up around the event, as options markets are underpricing potential moves around the Warsh hearing. Some market participants believe the Fed would be more inclined to cut rates under Warsh than under current Chair Jerome Powell. Others caution that there may not be enough support among policymakers to meaningfully shift policy and that Warsh himself may prove less dovish than markets expect.