(Bloomberg) -- Treasuries and most global peers retreated as renewed clashes in the Persian Gulf spurred gains in oil prices and fueled concern over inflation.
US 10-year yields are poised to snap their longest streak of declines in six months, advancing one basis point to 4.49% due to waning optimism that a peace deal may soon be reached to the end the war between the US and Iran. Swaps imply around an 80% chance the Federal Reserve under new chair Kevin Warsh will deliver a quarter-point interest-rate hike by year-end, while the Bloomberg Dollar Spot Index climbed 0.1% in a third straight day of gains.
Brent crude futures jumped as much as 4.2% to rise above $98 a barrel. That's after US forces carried out air strikes on an Iranian military site and struck other targets near the Strait of Hormuz. Iran targeted "the American airbase from which the attack originated," Press TV reported in a X post, citing the Islamic Revolutionary Guard Corps. Separately, Kuwaiti Air Defenses said they were responding to missile and drone threats.
The report of Iran's attack on a US military site has been the most likely driver, said Ken Crompton, head of rates strategy at National Australia Bank Ltd.
"That's dented equities appetite a little, and is flowing through to higher oil and bond yields too," he said. "We're still generally bearish on longer-end Treasuries: fiscal pressures in many markets, a growing risk that inflation expectations do become gradually less anchored after five years of above-target inflation, and an FOMC that's becoming increasingly open to rate hikes."
Federal Reserve Vice Chair Philip Jefferson warned that inflationary risks remain tilted to the upside, adding that he's watching for signs that higher energy costs stemming from the Iran war are dragging on consumer spending. Minneapolis Federal Reserve President Neel Kashkari warned that inflation is still "much too high," in an interview with CNBC.
The US also imposed new sanctions to prevent Tehran from profiting from vessels transiting the Strait of Hormuz, underscoring the precarious nature of recent diplomatic progress between the two sides.
Despite the bond market swings tied to the prospect of a peace deal, volatility has fallen sharply toward levels seen before the outbreak of the war at the end of February as evidenced by the ICE BofA MOVE Index, which estimates bond-market volatility.
"The volatility surface is increasingly pricing a continuation of the current equilibrium regime," Morgan Stanley strategists including Shaun Zhou wrote in a client note published Wednesday. However, they note several sources of instability remain under-appreciated, citing energy, callable supply, and cleaner positioning, that argue for higher intermediate vol.
Concern over higher oil prices also pressured most other nations' government bonds on Thursday. Australia's 10-year yield climbed as much as six basis points, while German equivalents rose one basis point to 3%. The UK was a rare exception with the 10-year gilt yield falling one basis point to 4.85%.
Nicolas Bickel, group head of investment private banking at Edmond de Rothschild, said the firm is cautious on long-dated government bonds. The term premium, or the extra compensation that investors demand for holding a longer-maturity bond instead of rolling over a series of shorter-term bonds over the same horizon, is too low given the risks, he said.
"If inflation stays high, if the debt stays very high too, and if we don't see an inversion across the world of these trends, then investors will demand higher yield for the long term, whether it is the Treasury or the gilt or the bund," he said. The firm tends to be underweight sovereign debt and favors credit instead, he added.
--With assistance from James Hirai and Georgia Hall.
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