Treasury yields declined sharply Tuesday as investors returned from Memorial Day weighing prospects of a Middle East peace deal against continued military tensions, with the benchmark 10-year note falling more than 8 basis points to 4.485% despite fresh U.S. strikes on Iran. The yield movements reflect market optimism about potential resolution to a conflict that has kept the Strait of Hormuz closed and pushed oil prices to four-year highs, even as hostilities continue.
The 2-year Treasury note yield, which more closely tracks short-term Federal Reserve interest rate policy, dropped 7 basis points to 4.057%. The longer-dated 30-year Treasury bond yield declined more than 7 basis points to 5.009%. One basis point is equal to 0.01%, and yields and prices move in opposite directions. Yields fell across the board, catching up with large declines seen in European sovereign yields on Monday, though European bonds gave some gains Tuesday as investors weighed mixed signals around the status of U.S.-Iran peace talks.
Military Tensions Persist
U.S. forces carried out what Central Command described as "self defense" strikes in southern Iran early Tuesday. Secretary of State Marco Rubio, who is in India, said that the Strait of Hormuz will ultimately have to be opened "one way or the other." Iran's Islamic Revolutionary Guard Corps said Tuesday it would retaliate against violations of the ongoing ceasefire after it identified and engaged U.S. drones and an F-35 jet fighter that entered the country's airspace. The apparent flare-up in hostilities came despite President Donald Trump earlier indicating in a Truth Social post that a peace agreement could be in sight, with negotiations "proceeding nicely."
Looking ahead, investors will be monitoring a slew of economic data released later this week, including April's personal consumption expenditures report, the Fed's preferred measure of assessing inflation. Bank of America forecasts a 0.4% increase from March and a 3.8% increase in headline PCE year-on-year.
Market Rally Continues
Wall Street futures gained on hopes of U.S.-Iran peace talks. The S&P 500 on Friday clinched its eighth straight weekly gain, the index's longest winning streak since 2023, as strong corporate earnings and AI enthusiasm helped investors look past concerns about the war with Iran. In the bond market, U.S. Treasury yields were trading at their highest levels in a year, and traders expected the Federal Reserve to keep interest rates on hold in the coming months, with a chance of a rate hike later this year, according to CME FedWatch. That was because the Strait of Hormuz remained closed, oil prices were at four-year highs and inflation expectations were moving higher.
Higher Treasury yields mean more expensive loans and mortgage rates, burdening consumers when sentiment is at record lows, according to the University of Michigan's long-running survey of consumers. The S&P 500 has clinched 18 record highs this year and is less than 0.5% away from hitting another. The AI buildout and tax cuts from President Donald Trump's "One Big Beautiful Bill Act" have helped push shares higher, with gains concentrated in technology and AI-related stocks. Since the war with Iran began, the S&P 500 is up about 8.6%, while an equal-weighted version of the S&P 500 is up less than 1%.
Corporate Earnings Strength
Corporate America continues to post strong profits. The S&P 500 is set to post the highest quarterly earnings growth rate since 2021, according to FactSet. First-quarter earnings growth is expected to be about 29% year-over-year, up from a prior estimate of 16.1%. The market is being driven by a narrow set of stocks, and investors are watching whether higher yields and inflation pressures will eventually weigh on valuations. The Atlanta Federal Reserve's daily tracker of economic growth pins U.S. GDP at 4.3%, and unemployment in April was unchanged at 4.3%, relatively low. A core measure of the Consumer Price Index that strips out food and energy rose 2.8% year-over-year in April. If core CPI heats up to more than 3% year-over-year in the coming months, higher yields are likelier to pressure stock prices. Investors and strategists said the market can digest higher yields if the economy keeps growing well, but if inflation fears intensify and bond market volatility increases, it could outweigh the positive outlook on economic growth.
Why This Matters:
The intersection of geopolitical risk and market performance underscores the resilience of American enterprise even amid significant external pressures. Strong corporate earnings growth of 29% year-over-year demonstrates that tax policy reforms and business investment in technology are delivering tangible results for shareholders and the broader economy. However, the narrow concentration of gains in AI-related stocks and the divergence between the S&P 500 and its equal-weighted counterpart raise questions about market breadth and sustainability. The prospect of higher inflation—driven by oil price pressures from the closed Strait of Hormuz—could force the Federal Reserve into tightening monetary policy at a time when consumers are already burdened by elevated borrowing costs. With mortgage rates and loan costs rising alongside Treasury yields, household budgets face increasing strain despite low unemployment. The administration's diplomatic efforts to resolve the Iran conflict carry significant economic implications beyond regional stability, potentially determining whether the current market rally can broaden beyond tech giants or whether inflation concerns will ultimately constrain valuations across the economy.