The U.S. and Iran reached a provisional agreement to reopen the Strait of Hormuz, leading to a continued decline in Brent crude oil prices and cooling inflation expectations, which triggered a global bond market rally. The yield on the 2-year U.S. Treasury note fell by as much as 7 basis points, and the probability of a Federal Reserve rate hike this year retreated from 80% to 70%. UBS believes falling oil prices will ease the pressure on Fed Chair Wash to hike rates. On Wednesday, Wash will chair his first Federal Open Market Committee meeting.

A provisional agreement between the United States and Iran to reopen the Strait of Hormuz has sparked a broad rally in global bond markets, with traders promptly scaling back their bets on a Federal Reserve interest rate increase this year. The sustained drop in Brent crude oil prices has led to a corresponding cooling of inflation expectations.

Data from the swaps market shows the probability of a 25-basis-point Fed rate hike before December fell from roughly 80% last Friday to about 70%. Yields on U.S. Treasuries of all maturities moved lower, led by declines at the short end, which is most sensitive to monetary policy. The 2-year yield fell as much as 7 basis points to 4.01%, while the 10-year yield dropped 6 basis points to 4.42%.

The drop in oil prices triggered by the agreement news directly eased market concerns about a further acceleration in inflation. The decline in U.S. Treasury yields simultaneously affected several market areas, including corporate bonds and emerging market assets. Bond markets in Europe and Asia also saw synchronous rallies, while the U.S. dollar's decline was directly linked to a reduction in safe-haven demand.

Fabio Bassi, Head of Cross-Asset Strategy at JPMorgan Chase & Co., stated: "Investors believe lower oil prices will reduce the need for developed market central banks to take more aggressive rate hike measures. However, market participants have grown accustomed to the impact of repeated news on the Middle East situation, so they maintain a degree of skepticism about the current circumstances."

Yields Decline Across the Curve, Pressure on Short Positions

The retreat in U.S. Treasury yields was evident across the entire yield curve. The 2-year yield fell as much as 7 basis points to 4.01%, while the 30-year yield dropped as much as 5 basis points to 4.92%, hitting its lowest level since May 7th.

Tomo Kinoshita, Global Market Strategist at Invesco Asset Management Japan, pointed out that based on historical correlations observed post-conflict, for every 10% drop in oil prices, the yield on the U.S. 10-year Treasury note would correspondingly fall by approximately 13 basis points.

Matthew Haupt, Portfolio Manager at Wilson Asset Management, said: "Some short positions in interest rate products will be unwound. Central banks can be less hawkish now because they can wait and ignore any short-term inflation."

In Europe, bond yields also generally declined, with traders simultaneously lowering their expectations for rate hikes from the Bank of England (scheduled to meet this Thursday) and the European Central Bank. The ECB had already taken the lead last week by raising its borrowing costs by 25 basis points, becoming the first major central bank to take such action.

Fed Decision Imminent, Pressure on Wash to Hike Eases

The Federal Reserve will announce its policy decision this Wednesday, which will also be the first interest rate decision meeting chaired by the new Chair, Wash.

Economists expect the Federal Open Market Committee to maintain the benchmark interest rate in the 3.5%-3.75% range, while waiting to observe the actual economic impact of the energy price shock stemming from the Iran conflict. Previously, U.S. consumer price increases had hit their fastest pace in three years, prompting a sustained rise in voices within the FOMC supporting a rate hike.

Leslie Falconio, Head of Taxable Fixed Income Strategy for Global Wealth Management at UBS Group AG, stated that falling oil prices are reducing the pressure on Chair Wash to hike rates.

She noted that before the ceasefire news emerged, "the two-year yield was still rising because the market was pricing in a near 100% probability of a hike by December 2026." With oil prices falling, the market is removing these hike expectations, thereby driving short-end yields lower.

Falconio expects the FOMC to formally remove its dovish bias at this week's meeting, issuing forward guidance that leans more hawkish. However, she added that she still anticipates the Fed's next move will be a rate cut, likely in the first or second quarter of 2027.

She stated that the Fed holding steady would allow policymakers to assess the economic growth trend, which is "still struggling to maintain," and the subsequent direction of the labor market. "I think they'll exercise the option they have, wait and see, and then make changes once the data comes in," she said.

Divergent Interpretations of Agreement, Market Enters Anxious Waiting Period

Despite the overall positive market sentiment, the uncertainty surrounding the implementation of the agreement cannot be ignored. According to a previous report, there are significant differences in the statements from the U.S. and Iran regarding Strait transit fees, indicating the difficulty of ultimately reaching an agreement on unresolved issues related to Iran's nuclear program.

Andrew Ticehurst, Strategist at Nomura Holdings, Inc., stated: "The Strait is expected to reopen on Friday, so there may be an anxious waiting period from now until then. Israel's actions during this period could also become a variable."

Regarding the U.S. dollar, the Bloomberg Dollar Spot Index, driven by reduced safe-haven demand, fell to its lowest point since June 5th. However, since the U.S. and Israel attacked Iran in late February, the index has still accumulated a gain of approximately 1.4%, and traders' overall attitude towards the dollar remained positive last week.

Looking ahead, Fabio Bassi expects the yield on the 10-year U.S. Treasury note to be near 4.70% by year-end and believes that if the yield rises above that level, it would provide a buying opportunity for long-term investors.