Interest rates on bonds have been on a roller coaster in recent weeks.
For investors, the ride has been particularly disorienting because rates haven’t moved the way you might expect. Typically, when markets become suddenly fearful, Treasury bonds rally in price—and yields fall—as investors seek safe-haven assets. (Bonds prices and yields move in opposite directions.)
But since the start of the Iran conflict the opposite has occurred. Treasury yields have risen, prices have fallen, and volatility has jumped, with large day-to-day swings in the market.
Big market moves often tell a story about investor expectations. Yet in this case, Fidelity’s fixed income managers say the bond market isn’t sending a single, clear signal so much as engaging in a tug-of-war under the surface—over what the Iran conflict may mean for inflation and growth, how it complicates the Fed’s path, and what it implies for deficit funding.
Read on for a closer look at what’s been happening under the hood of the Treasury market, plus why it may be creating opportunity for bond investors.
5 forces shaping Treasury yields now
The Treasury market is dealing with uncertainty on more fronts than usual. That’s why recent volatility has been so hard to read: Multiple forces are pushing yields in different directions at the same time, sometimes reinforcing each other and sometimes canceling each other out.
1. The inflationary impact of energy market disruptions
When investors grow more concerned about inflation, they typically demand higher interest rates as compensation. Michael Plage, who comanages several Fidelity bond funds and ETFs, including Fidelity® Total Bond Fund (
“Shorter-term interest rates have been impacted by the anticipated inflation impact of higher oil prices while the Strait of Hormuz is closed,” says Plage. He notes that inflation expectations, as implied by the Treasury Inflation-Protected Securities (TIPS) market, have changed since the start of the Iran conflict—with the market now expecting higher inflation over the next 1 to 5 years, but essentially no change in longer-term inflation expectations.
The bottom line: The expected inflationary impact of the Middle East conflict has been pushing up shorter-term interest rates.
2. Renewed uncertainty about the Fed’s path
With the inflation outlook up in the air again, investors feel less confident that the Fed may be cutting rates this year. “Inflation is one thing, but the bond market also cares about the Fed’s reaction function to that inflation,” says Plage. While Fed Chair Jerome Powell did not explicitly put rate hikes back on the table at the last Fed meeting, the market still appears uneasy about how the Fed would respond if inflation proves persistent.
All else equal, a higher expected fed funds rate—or less confidence in rate cuts—can push up interest rates across all maturities. Moreover, the range of possible outcomes for Fed policy seems to be wider now than before the start of the conflict. That heightened uncertainty can increase the risk of owning bonds and prompt investors to demand higher rates.
The bottom line: Previously, the bond market was betting on rate cuts this year, and now it isn’t. That, plus higher uncertainty about the Fed’s path overall, has helped push rates up.
3. The recessionary risk of higher oil prices
Fidelity's Asset Allocation Research Team, which conducts research on the economy and business cycle, does not see meaningful near-term recession risk—a view broadly echoed by market pricing. But the longer consumers and businesses are forced to absorb higher energy prices, and the higher those prices rise, the greater the risk that economic growth eventually slows.
“If oil prices stay higher for longer, at what point does that start to cut into growth expectations?” asks Christine Thorpe, Fidelity fixed income institutional portfolio manager. Slower growth expectations typically put downward pressure on interest rates. So far, that force hasn’t dominated—as reflected in the overall rise in Treasury yields. But Thorpe says growth risk remains part of the tug-of-war under the surface, contributing to the market’s volatility.
The bottom line: Investors would expect higher recessionary risk to push rates down. While the market is clearly weighing this risk, it’s been overpowered by other drivers.
4. Fresh focus on an old worry: deficits
Concerns about the US federal fiscal outlook are not new. But the Iran conflict has pushed those concerns to the forefront of bond investors’ minds. “Nobody knows when US debt and deficits are going to be a problem, but the conflict in Iran and the cost of funding that conflict over an uncertain timeline have reinvigorated the concerns,” says Plage. When the US issues more debt, the market must absorb more bonds, which can put downward pressure on prices and upward pressure on yields as supply and demand become unbalanced.
Plage notes this has been one of the dominant forces pushing up longer-term Treasury rates, like 10-year and 30-year rates. The US Treasury has been relying heavily on issuing short-term debt to finance the deficit. But the market is increasingly worried it may need to issue more long-term bonds in the future—precisely at a time when the economic and rate outlook is so uncertain.
The bottom line: Renewed focus on deficits—and how to finance those deficits in an uncertain rate environment—have been pushing up long-term Treasury rates.
5. Investors demanding more compensation for longer-term risks
Finally, taken together, these forces have made investors more cautious about investing for longer periods. When uncertainty and volatility rise, investors tend to demand higher yields as compensation for investing in longer-duration bonds. This has helped push yields higher—particularly on longer-term bonds, whose prices are most sensitive to uncertainty about inflation, policy, growth, and supply.
The bottom line: Bond investors aren’t focused on one specific thing going wrong. But in this uncertain environment, they want more compensation if they’re going to take on exposure to 10-, 20-, or 30-year bonds.
What it means for investors: The role of bonds in a portfolio
Recent moves in Treasurys may be unsettling for investors who expect bonds to hold their ground during stock-market pullbacks. “People may be surprised to see bonds selling off at the same time as stocks are selling off,” says Thorpe.
She says it’s important to distinguish between market pullbacks driven by inflation concerns, and the corresponding Fed reaction, versus those driven by fears of an economic slowdown. In inflation-driven pullbacks—like the current one or the 2022 bear market—it’s not unusual for bonds to struggle alongside stocks. But during true risk-off periods driven by recession fears, Treasury bonds have been more likely to rally. She points to the market decline in 2008 as a classic example: Treasurys were one of the few asset classes to post positive returns through that period.
“Over time, I would still expect bonds to serve as that ballast in portfolios,” Thorpe says.
More attractive entry points
On the bright side, the recent increase in yields may have created more attractive entry points for investors. Treasury yields have traded largely within a range over the past few years, Plage says, and recent volatility has pushed them toward the upper end of that range.
Put another way, Treasurys have moved toward the cheaper end of their valuation range, says Beau Coash, Fidelity fixed income institutional portfolio manager. That’s why Fidelity fixed income managers have been finding better relative value in Treasurys than in other parts of the investment-grade market. By contrast, investment-grade corporate bonds and mortgage-backed securities have looked relatively expensive, Plage says.
In particular, Coash says the team has been finding value in the “belly of the yield curve”—meaning intermediate maturities such as 4- to 7-year bonds. He notes that Treasurys in that range may be particularly appealing now that longer-term bonds are again yielding more than shorter-term bonds (a scenario that bond professionals call a "positively shaped yield curve"). As these bonds age and naturally "roll down" toward lower yields, they may also have the potential to gain in price, supporting total return.
Should you buy Treasurys now?
Fidelity managers stress that their recent preference for Treasurys is about relative value—not a view that other investments should be avoided or that Treasurys represent the “best” investment for anyone.
For any investor, the decision to add Treasurys to a portfolio should be part of a long-term financial plan that takes into account goals, time horizon, risk tolerance, and the need for diversification across and within asset classes. Investors who determine that Treasurys fit within their plan can use Fidelity’s fixed income research tools to compare yields across maturities and search for both new-issue Treasurys and bonds trading in the secondary market.
Another option, which might be better suited to the market climate, is to consider actively managed investment-grade bond funds. It can be difficult for individual investors to nimbly navigate the research, trading, and minimum-investment requirements of the vast and complex bond markets. Coash notes that for an active bond manager, relatively high Treasury yields can provide a place to earn a decent yield on dry powder—while watching for future opportunities the market may turn up.
To learn more, investors can research mutual funds or explore Fidelity’s fixed income funds.