Bond market expects high yields to persist even after Iran war ends

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Bond market expects high yields to persist

Highlights

The Treasury market is no longer pricing in rapid Fed rate cuts.
Kevin Warsh’s appointment has strengthened expectations of a tougher anti-inflation stance.
The war with Iran has lifted energy prices and increased pressure on consumer prices.
Futures now allow for a 25-basis-point rate increase by the end of 2026.

Bonds reprice the Fed

Kevin Warsh officially took office as chair of the Federal Reserve Board on May 22, 2026; his four-year term will run through May 21, 2030. He also became chair of the Federal Open Market Committee, which sets U.S. interest-rate policy.

For markets, this means a shift in expectations. According to Bloomberg, Treasury investors are now betting that Warsh will focus first on defending the Fed’s anti-inflation credibility rather than yielding to political pressure for lower rates. Federal funds futures now point to the possibility of a quarter-point rate increase by the end of 2026.

That marks a sharp reversal from the start of the year, when markets were still debating the timing of future rate cuts. The central question has now changed: not when the Fed will begin cutting rates, but how long it will need to keep financial conditions tight.

The Iran shock may not fade quickly

The conflict in the Middle East has become the main external factor intensifying inflation risks. Richmond Fed President Thomas Barkin said the U.S. economy has faced a series of supply shocks — from the pandemic and the war in Ukraine to tariffs and the current conflict in the region. According to him, higher gasoline prices are already being accompanied by fuel surcharges, higher airfares, transportation and packaging costs, as well as shortages or limited availability of some goods, including fertilizers and aluminum.

Barkin noted that headline PCE inflation rose to 3.5% year over year in March, while core inflation reached 3.2%. Inflation has remained above the Fed’s 2% target for more than five years, raising questions about the central bank’s previous practice of looking through temporary supply shocks.

Even if geopolitical tensions ease, the effect on prices may persist. Barkin warned that the consequences depend on the length of the conflict and the time needed to restore supply chains. He also said gasoline prices could take months to fall even after the reopening of the Strait of Hormuz.

A new price of risk for markets

Elevated Treasury yields are changing conditions across all asset classes. For equities, they mean a higher discount rate for future earnings, especially in expensive technology segments. For companies, they mean more costly debt. For consumers, they add pressure through mortgages, auto loans and credit cards.

The key figure for the Fed now is not only the level of interest rates but the persistence of inflation: 3.5% headline PCE, 3.2% core PCE and more than five years above the 2% target. If Warsh concludes that the inflation anchor is weakening, the bond market may settle into a new regime: yields will remain high not because of the war itself, but because investors expect the Fed to respond more forcefully to repeated shocks than it has in the past.

We also reported oil prices fall on progress in U.S.-Iran talks.

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