Key Takeaways:
Bond markets are pricing a messy stalemate in the Middle East rather than a clean resolution, pushing the 10-year yield below 4.51% even as U.S. forces strike Iranian targets.
U.S. Treasury yields fell as much as 7 basis points Tuesday, with the 10-year note dropping to 4.502%, as hopes for a reopening of the Strait of Hormuz offset fresh U.S. military strikes in southern Iran.
"Hopes that the Strait of Hormuz will be fully reopened soon have helped to calm fears about runaway inflation," said Raffi Boyadjian, an analyst at XM.
The 2-year yield fell 5.9 bps to 4.066%, while the 30-year bond yield declined 5.1 bps to 5.030%, according to Tradeweb. The moves caught up with Monday's sharp declines in European sovereign bonds, when U.S. markets were closed for Memorial Day. The 10-year Bund yield hit a six-week low of 2.930% on Monday before rising 1.5 bps to 2.961% Tuesday as investors weighed the mixed signals.
The conflicting dynamics leave markets in what capital.com senior market analyst Daniela Hathorn described as a "messy stalemate" scenario, where the ceasefire broadly holds but sporadic attacks and diplomatic setbacks keep energy markets on edge. Brent crude, which tumbled nearly 7% Monday to $96.30 on peace optimism, rebounded above $98 Tuesday after the U.S. strikes.
The U.S. Central Command said it conducted "self-defense" strikes in southern Iran targeting missile launch sites and boats attempting to lay mines. Iran's Islamic Revolutionary Guard Corps responded by saying it would retaliate against violations of the ceasefire after identifying and engaging U.S. drones and an F-35 jet fighter that entered Iranian airspace. The flare-up came despite President Donald Trump indicating on TruthSocial that a peace agreement could be in sight, with negotiations "proceeding nicely."
Iran's top negotiator and foreign minister were in Doha for talks with Qatar's prime minister on a potential deal to end the three-month-old war. The Nikkei newspaper reported that both parties were discussing a plan to open the Strait of Hormuz about 30 days after reaching an agreement.
Strait of Hormuz premium lingers
The waterway handles about 21% of global oil trade, and its effective blockade has pushed U.S. gasoline prices above $4.50 a gallon, with California exceeding $6. Morgan Stanley expects gasoline inventories to hit a seasonal record low by the end of August. The last time oil supply disruptions of this magnitude occurred — during the 2019 attacks on Saudi Aramco's Abqaiq facility — crude prices spiked 15% in a single session before retreating within weeks as spare capacity was deployed.
The dollar weakened against major peers, with the euro rising to $1.16365 and the yen firming to 158.95 per dollar, as easing geopolitical risk reduced demand for the greenback. Gold slipped 0.6% to $4,544.33 Tuesday after gaining 1.2% Monday, as competing narratives around inflation and rate expectations kept the precious metal range-bound between $4,450 and $4,600.
Investors now face a week packed with economic data that could reshape rate expectations. April's personal consumption expenditures price index — the Federal Reserve's preferred inflation gauge — is due Friday. Bank of America forecasts a 0.4% monthly increase and a 3.8% year-on-year headline reading. Markets currently price at least one additional 25-basis-point rate hike from the Fed this year, with some investors considering the possibility of further tightening rather than cuts.
This article is for informational purposes only and does not constitute investment advice.
