Markets still expect modest steepening driven by a gradual grind higher in the long end.
At the start of the year, markets were pricing in two to three Fed rate cuts by year-end, and consensus was building for a broad steepening of the Treasury curve. Fast forward to today, markets have quickly repriced and expect no easing from the central bank this year.
The U.S.-Iran conflict and its impact on oil prices has been the primary catalyst. Oil prices have almost doubled since the start of the year, and with them, near-term inflation expectations. That one-two punch — fewer expected rate cuts and hotter short-term inflation — has driven the 2-year Treasury yield roughly 40 basis points higher. Longer-term rates (10-year) have moved up more modestly, rising about 15 basis points. Notably, long-term inflation expectations have barely budged — 10-year inflation breakevens are up only about 11 basis points since the conflict began. The bond market is treating the oil shock as a near-term problem, not a permanent one.
The result, as our updated yield curve chart on page 36 of the 2Q 2026 Guide to the Markets shows, has been a flattening of the curve — the opposite of what most forecasters expected. Going forward, markets still expect modest steepening driven by a gradual grind higher in the long end, while the Fed remains on pause.
We see things playing out differently, however. Should the Iran conflict find resolution by the summer, oil prices are likely to retreat quickly, and near-term inflation pressures should ease with them. That could be enough for the Fed to cut rates once this year and continue cutting into next year— a scenario markets aren’t pricing in. Moreover, the recent spike in prices may have already done enough damage to weaken consumption and overall economic activity through the middle of the year, supporting gradual Fed easing and rates coming down.
Underneath the surface, positioning may have been a contributing factor. Speculative traders in the futures market have built up a very large bet that rates will keep rising — one of the more crowded positions we’ve seen in recent years. Meanwhile, longer-term institutional investors have been doing the opposite, steadily adding to bond holdings. When one side of a trade gets this lopsided, it often sets the stage for a sharp reversal if the narrative shifts. Technical indicators for the 10-year Treasury are also flashing signs that the recent bond selloff is running out of steam. If our thesis plays out, those large short positions would likely unwind fast, amplifying a bond rally.
Where does that leave investors? We think short- to intermediate bonds look particularly attractive — yields near 4% with meaningful upside if consumption growth softens and the Fed does resume easing.