Inflation data and Warsh in focus as yields rise

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Ongoing strikes between the US and Iran jolted markets at the start of the week, with Brent crude rising above USD 86/bbl at the time of writing, its highest level in a month, and the 10-year Treasury yield climbing above 4.6% for the first time since May. The US announced the reinstatement of the naval blockade against Iran from Tuesday, and US President Donald Trump demanded a 20% fee on all other vessels crossing the Strait of Hormuz.

The US consumer price index (CPI) release for June, due on Tuesday, will be key to watch, and a higher-than-expected print could further intensify investor concerns over tighter Federal Reserve policy and push up bond yields. Fed Chair Kevin Warsh’s testimony before Congress on Tuesday and Wednesday will also be scrutinized for any signals on the central bank’s interest rate path.

We still believe that both Washington and Tehran will seek to avoid a return to all-out war, and that an eventual diplomatic solution should allow energy flows through the Strait to normalize gradually. This should ease inflation worries and lead to a decline in yields as the year progresses.

Inflation should moderate in the coming months after peaking in May. Consensus estimates point to a deceleration of headline CPI to 3.8% year over year in June, from 4.2% in May, with core inflation holding steady at 2.9% year over year. This would be in line with our view that inflation peaked in May, as tariff-related price increases abate and energy prices decline. With wage growth no longer a primary driver of inflation, we expect price pressures to moderate in the second half of the year, reducing any urgency for the Fed to raise interest rates.

Fed rhetoric may soften later this year. Speaking before the US House Financial Services Committee, Warsh is likely to field questions on the central bank’s plans for its balance sheet. But as was the case with his speech at the European Central Bank’s annual forum in Sintra two weeks ago, Warsh is expected to give little indication of where he sees monetary policy heading. We believe Warsh and Fed officials will maintain their hawkish stance in the near term, but we also expect rhetoric to soften once they become more confident that second-round inflation effects are limited.

Slower growth and the review of Fed operations should keep the central bank from making major policy changes. While the US economy remains resilient, we expect softer growth conditions to re-emerge in the coming months, as diminishing fiscal support and weaker real income growth weigh on household consumption. Separately, the introduction of multiple task forces as the Fed reassesses its framework and tools for policymaking also means that the US central bank is likely to delay any major policy reaction in the near term, in our view.

So, we maintain the view that market pricing of Fed policy is too hawkish, and that bond yields should fall from their current elevated levels. This creates an opportunity for investors to lock in attractive portfolio income by adding to quality fixed income, especially in the short- to medium-maturity segments.