Surging oil prices have intensified inflation concerns, driving U.S. Treasuries toward their largest weekly decline since April 2025. Despite an unexpectedly weak U.S. jobs report—which would typically support the case for Federal Reserve interest rate cuts—anxiety over inflation has completely overshadowed this positive signal. Long-term bonds performed particularly poorly on Friday, with the 10-year Treasury yield rising by 5 basis points at one point. For the week, the yield climbed by 22 basis points, marking the biggest weekly increase since former President Trump announced sweeping tariffs on U.S. trade partners nearly a year ago. Traders are now betting that the Fed will cut rates at least once this year, potentially as early as September. Ian Lyngen, head of U.S. rates at BMO Capital Markets, noted, "Intuitively, the forward-looking inflation risks stemming from Middle East conflict are making it difficult for the Treasury market to extend its rebound."

Yields on 10- to 30-year U.S. Treasuries moved higher on Friday as Brent crude futures touched $90 per barrel. In contrast, the more policy-sensitive 2-year Treasury yield declined, falling about 2 basis points to around 3.6%, which trimmed its weekly gain to 18 basis points. This week's movements are setting the tone in the $31 trillion U.S. Treasury market. Investors are focusing on energy costs and their potential ripple effects on global inflation and central bank policies, rather than on the latest signs of labor market weakness. Government reports showed that U.S. employers cut 92,000 jobs in February and the unemployment rate increased. Data also indicated that U.S. retail sales declined in January, with auto dealerships performing weakly as winter weather disruptions suppressed some economic activity. Guy LeBas, chief fixed income strategist at Janney Montgomery Scott, commented, "Today’s jobs data look recessionary. Normally, when employment figures fall significantly short of expectations—especially against a backdrop of a fragile labor market—we would see the entire yield curve rally sharply. But clearly, that hasn’t happened. The link between energy prices and interest rates has outweighed the economic downside pressure evident in today’s data."

U.S. policymakers cut rates three times last year as the labor market softened but paused in January, with several officials arguing that inflation remained too high to justify further near-term easing. However, the latest employment data gives Fed officials concerned about the labor market reason to advocate for additional policy accommodation. San Francisco Fed President Mary Daly said on Friday that the disappointing jobs report challenges the view that the U.S. labor market is stabilizing. Fed Governor Christopher Waller stated that he does not expect the Middle East conflict to have a "lasting" impact on inflation. Waller dissented from the Fed’s January decision, saying that given persistent signs of labor market weakness, he would have preferred a 25-basis-point rate cut. Interest rate swap data indicate that traders have recalibrated their Fed policy expectations this week due to the escalating Middle East conflict. They now anticipate that U.S. policymakers will deliver a total of 36 basis points in rate cuts by the end of this year, with the next cut expected in September. A week ago, the market was pricing in 60 basis points of cuts for 2026. Kevin Flanagan, head of investment strategy at WisdomTree, said, "The bond market has decided to focus on high oil prices and their potential inflationary impact. For the Fed, the best course of action may be to wait and see."

The conflict has also significantly altered the outlook for the European bond market, where the region is particularly vulnerable to energy shocks. Money markets now expect the European Central Bank to raise interest rates in 2026, a complete reversal from a week ago when markets saw a greater probability of rate cuts than hikes. Swaps are fully pricing in a 25-basis-point rate hike by December of this year and assign about a one-third probability of another hike by April 2027. This has put German government bonds on track for their worst weekly performance in three years. Globally, investors and policymakers continue to debate whether the inflationary impact of rising oil prices will be temporary. The Fed previously misjudged the persistence of inflation in the post-pandemic period and following Russia’s invasion of Ukraine in 2022. Priya Misra, a portfolio manager at J.P. Morgan Asset Management, observed, "The market is questioning whether the overall economic environment is resilient enough to handle the stagflationary shock and uncertainty brought by energy prices. All markets are built on two assumptions: that the conflict will be short-lived and that economic fundamentals are solid. Both of these assumptions are now being challenged."