(Bloomberg) -- Treasuries rose on Tuesday as signs of progress toward a diplomatic resolution of the Iran war sent oil prices lower, curbing expectations for more than one Federal Reserve interest-rate hike in the coming year.
Yields fell across maturities by four to six basis points, with the yield on the two-year note reaching the lowest level since July 20 and the benchmark 10-year yield at 4.62%. Treasury yields have tracked oil prices to varying degrees since the US attacked Iran in late February, helping push up inflation and bolstering the case for tighter US monetary policy.
On Tuesday, West Texas Intermediate crude futures fell nearly 6% to their lowest since July 13, following comments by US Treasury Secretary Scott Bessent and representatives of Qatar suggesting the US and Iran were close to an agreement — the latest in a series of similar developments since the war began.
"In an environment where Fed credibility is at stake and some Fed officials are losing patience with the fact that inflation has been above the Fed's 2% target for five years, we think that Treasuries will continue to be driven by movements in oil prices," said Priya Misra, portfolio manager at JPMorgan Asset Management.
Short-term interest-rate futures contracts price in about 15 basis points of Fed tightening for the next policy meeting in September, more than half of a quarter-point hike. An increase is fully priced in by year-end. As recently as last week, two hikes were fully priced in.
The Treasury market has also been contending with the possibility that a robust US economy may require higher interest rates to curb inflation regardless of oil prices, with investors awaiting the July employment report on Friday to potentially provide clarity on that point. In the meantime, Tuesday's data on June job openings drew scant market reaction as it showed a bigger-than-estimated decline.
In an essay published Tuesday, Philadelphia Fed President Anna Paulson said she was "keeping an open mind" on the direction of policy amid conflicting signs on whether it's restrictive enough.
"Falling oil prices should ease inflation expectations and support a more stable Fed policy outlook," said Sean Simko, head of fixed-income investment management at SEI Investments Corp.
Adding to upward pressure on Treasury yields in recent weeks has been the prospect of increases in the supply of notes and bonds in the coming year. While the Treasury Department has indicated the increases are still at least several quarters in the future, its next quarterly policy statement to be released Wednesday is a possible vehicle for signaling that the era of stability in auction sizes is approaching its end.
Related story: Bond Dealers Expect US Will Avoid Signaling Auction Increases
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