Higher
“Can you take me higher?” asked Scott Stapp in Creed’s hit from 1999, “Higher.” Last week, the Treasury market answered yes. The yield on the 10-year note reached 4.69% on Wednesday, a level not seen since January 2025. Meanwhile, the 30-year T-bond reached 5.19%, a yield not seen since the eve of the Global Financial Crisis in 2007 (Figure 1).
The ongoing conflict in the Middle East has dominated headlines in recent months, and energy prices have been a big focal point of the story. Gas prices in the U.S. rose by almost 28% over the past two months, according to the BLS. Similarly, the daily national average price of unleaded exceeded $4.50, nearing the all-time high set in the summer of 2022, according to the American Automobile Association (Figure 2).
The CPI report also noted that grocery prices, rents, and airfares saw large increases from a month earlier. The moves for gasoline and airfares were fairly predictable, but the April jump in rent was unexpected—and, our analysis shows, more of a one-off event due to data distortions from the government shutdown.
Unlike most CPI categories, shelter inflation was not fully “caught up” after the government shutdown last fall because rent and owners’ equivalent rent are measured on a six-month property rotation. Without the BLS quirk on rents, core CPI would have printed 0.26% for April, instead of 0.4%, according to Bloomberg Economics. Yet once the data-tarnished housing sector is solved for, core inflation seems to be in check. Furthermore, tariff-exposed goods were flat, while some discretionary spending categories, like furniture/bedding, tools/hardware, and window coverings, are actually declining (Figure 3).
Figure 1: Yield on 30-year Treasury bond, 2008–present
As Barclays Capital noted, “with debt rising faster than growth, worsening inflation profiles, and no political will for fiscal reform, there is little reason to reach for the long end.” In other words, why buy now when — according to Barclays, at least—the future will offer ample opportunities to buy at even higher yields? For mortgages, this is obviously not the best news.
The catalyst for the climb higher in rates seems to be rising energy prices, which, in turn, are stoking inflationary fears and downstream restrictiveness from the Federal Reserve. Some analysts predict that the post-Iran war center of gravity for the 10-year note is likely to increase from the 4.25% zone to a new anchor of around 4.50%. The conflict in the Middle East is weighing dramatically on the energy market; as energy and transportation prices tick higher, price discovery continues to unfold in bond markets, resulting in higher Treasury yields.
Hopes for a peace deal, moreover, are fragile at best and rate hikes now seem imminent. Federal funds rate futures have now fully priced in one 25 basis point hike by the end of 2026.
While interest rates have been on the rise, relative volatility has declined in recent years: The one-year average yield of the 10-year Treasury note has hovered between 4.20% and 4.30% since May 2024, according to Mizuho Securities USA. That relative stability can be quantified statistically, too: The +/- 1 trailing 1-year standard deviation range is historically narrow (Figure 2), while the range within two standard deviations is now around 29 bps.
Figure 2: Yield on 10-year note, 2022–present
In absolute terms, the trading range has only been narrower about 8% of the time over the last 65 years. In relative terms (compared to the one-year average level of yields), the trading range has only been narrower 12% of the time over the last 65 years (Figure 3).
Figure 3: Yield on 10-year note, 1970–present
The Iran war has become the major contributor to volatility in the long end of the curve, as investors wait for a permanent resolution to the conflict. Instead of the typical flight-to-safety rally we’d normally see during war, we’ve seen violent swings in the yield on the 10-year note, due to the large fluctuations in energy prices. Inflationary angst, in short, continues to surge as the Federal Open Market Committee balances its dual mandate in an uncertain environment.
Fed Governor Christopher Waller, for example, said he supports making clear that the central bank’s next interest-rate move is just as likely to be an increase as a cut. “Inflation is not headed in the right direction,” Waller said on Friday. The minutes from April’s FOMC meeting struck a similarly hawkish tone. If inflation continues to run above the Fed’s 2% target, a majority of Fed officials warned that the central bank would need to consider raising rates. To deliver a clear message to the public, “many participants indicated that they would have preferred removing the language from the post-meeting statement that suggested an easing bias regarding the likely direction of the committee’s future interest-rate decisions.”
Unlike the beginning of 2026, when the Fed was signaling the start of an easing cycle, the Iran war has clearly caused the Fed to change its tune. As bond yields soar and the Strait of Hormuz remains effectively closed, Fed officials in recent weeks have warned about the ever-worsening inflation outlook. “I’ve been in favor of the easing bias for a long time,” Waller said. “But the last couple of labor market reports and inflation reports just turned me the other way.”
The beginning of a tightening monetary-policy era is not where new Fed Chair Kevin Warsh wanted to start. Indeed, Warsh was hoping to be the anti-Powell — and cut rates aggressively. Instead, Warsh faces worsening inflation, a surprisingly resilient economy, a stable labor market, an ongoing war, and a Fed that has all but made up its mind to start hiking rates. At his final press conference as Chair, Powell told reporters that the decision to retain the easing bias in the FOMC statement was “a much closer question” this time.
The Fed is not alone in this predicament, either. Other major central banks are expected to reverse course and raise rates in 2026 in response to the surge in inflation. For example, the market is currently expecting 42 bps of rate hikes from the Bank of Canada, 48 bps of hikes from the Bank of England, and 65 bps of hikes from the European Central Bank this year. The Reserve Bank of Australia already raised rates three times this year.
For now, oil seems to be the tail wagging the proverbial dog. The crude oil price, per barrel, hit new highs. There has also been a very high correlation between 10-year note yields and oil futures, particularly since the start of the Iran conflict (Figure 4). Those key prices have been making new local highs, both six and 12 months out, according to crude futures, thereby signaling the persistence of potentially greater inflation.
Figure 4: Prices of crude oil generic futures (left y-axis) vs. yields on 10-year Treasury notes (right y-axis)
The complexities of the oil market may only complicate the matter in upcoming weeks because production capacities have a large hurdle to turning back on if they’re shut down. Similarly, stockpiles of the precious commodity have been drained in recent weeks after a disappointing build cycle following the Covid pandemic. The initial drawdowns occurred in 2020 and have yet to reach the local trough set in summer 2023; but the drawdowns do seem to be heading the wrong way (Figure 5). A supply squeeze, coupled with low reserve inventory and a seemingly low chance of an accord, could create a challenging environment for lower-cost hopefuls.
Figure 5: U.S. Strategic Petroleum Reserve, millions of barrels, 1982–present
Despite the remarkably subdued volatility in the Treasury market, the path forward remains highly uncertain. Persistent inflationary pressures, coupled with the Fed’s necessary reaction function, continue to suggest a bias toward higher rates over the medium term. In the near term, similarly, rates appear increasingly tethered to movements in spot energy markets, with the ongoing conflict in the Middle East serving as the primary catalyst for volatility in oil prices.
As a result, markets will remain heavily dependent on geopolitical headlines and any progress — or deterioration — in negotiations between the U.S. and Iran. Even in the event of a successful peace deal, disruptions to oil production infrastructure could delay a full return to output capacity, prolonging upward pressure on energy prices. Add to this a new Fed chair, and this dynamic risks reinforcing the inflationary feedback loop that’s already weighing on the rates market, while further complicating the outlook for monetary policy. For now, the market keeps returning to the same lyric: higher.
FROM THE DESK
Agency CMBS — It was a light week for DUS origination volume, given the rise in rates and shortened trading day on Friday. Spreads — largely unchanged, week over week — were biased cautiously wider. Ginnie Mae volume was around $500 million and spreads were generally unchanged. We are seeing more new issues with shorter prepayment protection, likely driven by borrowers who believe that rates will be considerably lower in two to three years. Investors who go with that strategy will bear higher payments now, hoping later to lock in lower payments for longer. Many factors will determine whether their bet pays off. But one key factor working against them will be the rapidly rising amount of Treasury debt.
Municipals — AAA tax-exempt yields were higher throughout the yield curve, week over week. Municipal bonds came under pressure to start the week, driven by headline risk surrounding developments in the Middle East. The primary market struggled to clear supply, while multiple deals had unsold balances that dealers ultimately had to take down. Demand turned more selective as well, with investors requiring concessions to engage in new issues. More stable conditions returned at the end of the week. Investors put $1.5 billion into funds last week; high yield received only $1 million of those inflows.
ECONOMIC CALENDAR FOR THE WEEK AHEAD
The information contained herein, including any expression of opinion, has been obtained from, or is based upon, resources believed to be reliable, but is not guaranteed as to accuracy or completeness. This is not intended to be an offer to buy or sell or a solicitation of an offer to buy or sell securities, if any referred to herein. Lument Securities, LLC may from time to time have a position in one or more of any securities mentioned herein. Lument Securities, LLC or one of its affiliates may from time to time perform investment banking or other business for any company mentioned.
