"Growth panic" overwhelms "inflation anxiety": expectations of a rate cut by the Federal Reserve rekindle, triggering a dramatic rebound in US bonds.

As traders have been abandoning their bets on the Federal Reserve raising interest rates, the market focus has shifted to concerns that the Iran conflict may worsen economic slowdown. The U.S. Treasury market has rebounded strongly from its most severe sell-off in 17 months. Federal Reserve Chair Jerome Powell stated in a speech at Harvard University that the central bank is almost powerless against supply-side shocks (such as the surge in oil prices due to the U.S.-Iran conflict). This statement eased concerns in the market about the Fed being forced to tighten monetary policy to control accelerating inflation, prompting traders to consider the possibility of rate cuts later this year, although the probability is still low. The sudden shift in market sentiment led to a sharp drop in short-term bond yields by more than 10 basis points at one point, followed by a slight narrowing of the decline. This helped the U.S. bond market recover from its most severe monthly decline since October 2024 when investors were betting on President Trump injecting strong momentum into the economy. This rebound reflects growing concerns in the market that an escalation of the Middle East conflict could impact the U.S. economy, which is already facing a slowdown in job growth. Rising fuel prices are increasing costs for businesses and consumers. Monday's increase marked the second consecutive day of bond yields falling alongside rising oil prices. In most of March, as energy prices surged, yields rose in tandem, with the market at the time worried that the Iran conflict could lead to rising inflation. John Briggs, head of U.S. interest rate strategy at Natixis, said, "Before last Friday, investors seemed more concerned about the inflationary impact of rising oil prices, therefore pricing in Fed rate hikes, which pushed bond yields higher. However, the market sentiment has changed since then, even though oil prices are rising, the focus is now on concerns about economic growth." This marks a significant shift in the bond market concerns about inflationary impacts potentially restraining the Fed had largely overshadowed concerns about economic growth. Gennadiy Goldberg, head of U.S. interest rate strategy at TD Securities, said, "The market is uncertain about how to respond to recent geopolitical events should it focus on the first-level impact of inflation, or the second-level impact of economic growth. Not only is the geopolitical outlook unclear, but the market also lacks clarity on how the Fed will respond to these scenarios." At the start of last week, the futures market had fully priced in one rate hike before the end of the year, until last Friday, the market still considered the possibility of a rate hike very high. By Monday, market sentiment had quickly reversed, with traders at one point believing there was a 20% probability of a rate cut before the December meeting. Alyce Andres, macro strategist, said, "Signs of escalation in the Iran conflict and concerns about economic growth are driving the rise in U.S. Treasuries on Monday, but factors such as thin trading due to the month-end holiday and supply dynamics may continue to support buying in the bond market this week." Global bond markets move in sync The rebound in U.S. Treasuries has led to a simultaneous recovery in global bond markets, with yields on Japanese, British, and German government bonds all declining. The yield on the U.S. two-year Treasury note fell by 9 basis points to 3.82%, while the yield on the ten-year Treasury note dropped by approximately 9 basis points to 4.34%. Major U.S. bond funds, including PIMCO, have warned that financial markets are currently underestimating the risks of an economic slowdown as concerns about inflation heat up. Goldman Sachs has raised the probability of a U.S. economic recession in the next year to around 30%. The conflict, now in its fifth week, shows no signs of ending, even though the U.S. has extended the deadline for Iran to restart the passage through the Strait of Hormuz. On Monday, a key oil benchmark price remained above $110 per barrel. Although President Trump has previously stated on social media that the government is engaged in "serious discussions" with the Iranian regime, he has also threatened to attack Iran's oil and power infrastructure if an agreement cannot be reached. However, Iran has repeatedly stated that negotiations have not progressed and has hinted at the ability to engage in long-term warfare, increasing the risk of conflict delay and subsequently cutting off global critical energy supplies. Ian Lyngen, head of U.S. interest rate strategy at BMO Capital Markets, summed up: "Bond markets rebounded on Monday as investors focused on the potential risks to global growth related to the Middle East events, rather than just trading this conflict from the perspective of inflationary impacts."