Shorter-dated U.S. Treasury yields eased on Tuesday, as hopes of a diplomatic breakthrough between the United States and Iran pushed oil prices lower, supporting expectations that the Federal Reserve would not need to hike interest rates imminently.
The yield on the 2-year note, which closely tracks expectations for Federal Reserve monetary policy, was down 1.7 basis points at 4.198%, easing after three straight sessions of increases.
Tehran received a proposal from mediators for a 10-day ceasefire although the decision by the Iran-aligned Houthis to impose a naval blockade on Saudi Arabia on Monday risked further escalating the conflict, keeping Brent crude just below $90 a barrel, a five-week high.
U.S. inflation expectations have steadily eased this month even as oil prices remained elevated, with a market-based measure of one-year-ahead inflation falling below the Fed's 2% target for the first time since October 2024.
"Despite the recent rally in oil prices, market-based measures of inflation have stayed well anchored," strategists at ANZ Research said in a note, adding that the Fed's credibility in inflation management, receding tariff effects, and a non-inflationary labour market were among several factors that explained the stability.
"This may be indicating that monetary policy is restrictive." Two-year yields have fallen more quickly than those for benchmark 10-year debt, an indication of investor belief that the Fed is under less pressure to raise rates.
Data last week showed U.S. consumer prices increased at a slower pace than anticipated in June, prompting investors to rein in their bets on interest rate hikes.
Money markets largely expect the Fed to keep rates unchanged at 3.5%-3.75% at its July 28-29 meeting and have priced in a near 66% chance of a quarter-point hike by September.
The U.S. Fed is in a blackout period before its policy meeting next week and the U.S. economic calendar is light this week.
The benchmark U.S. 10-year yield was little changed at 4.598%.
With so much focus among investors on the outlook for inflation right now, an auction of inflation-linked debt later in the week could attract scrutiny.
The Treasury Department will sell $13 billion in 20-year bonds on Wednesday and $21 billion in 10-year Treasury Inflation-Protected Securities on Thursday.
