(Bloomberg) — Treasuries fell as quickening inflation stemming from the US war on Iran — and the prospect of escalation — eroded wagers that the Federal Reserve will lower interest rates once this year.

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The rise in yields began in early US trading after the release of consumer prices data for March — the first to reflect the impact of the war. Yields extended their climb to trade as much as five basis points higher after midday after US President Donald Trump threatened to escalate the war if weekend talks failed.

Late in New York trading, yields were up between three to four basis points across maturities. The setback pared a weekly gain for US government bonds sparked by an April 8 ceasefire agreement, which caused oil prices to tumble from near multiyear highs.

Short-term interest-rate contracts that predict the course of US monetary policy priced in a less than one-in-four chance of a quarter-point rate cut this year, slightly lower than before the data. A separate economic indicator showing erosion in consumer sentiment offset the impact of the inflation readings.

“We believe the Fed’s going to be on hold for the balance of the year, but if we don’t start to see commerce through the Strait and a drop in energy prices, inflation pressures in the short term will become more of an issue,” said Charlie Ripley, a portfolio manager at Allianz Investment Management.

The consumer price index rose 0.9% in March, the most in nearly four years, reflecting a surge in gasoline prices after the war curtailed the supply of oil via the Strait of Hormuz. The increase matched economists’ median estimate, while prices excluding food and energy — core CPI — increased 0.2%, less than the 0.3% estimate.

Separately on Friday, the University of Michigan’s consumer sentiment gauge for April fell to a record low, highlighting the risk to US economic growth stemming from rising consumer prices — which has helped contain the rise in Treasury yields since late March. Consumer inflation expectation gauges included in the sentiment report rose more than economists estimated.

The March CPI was the first to show the impact of the war, which effectively stopped the flow of oil from the region via the Strait, on US consumers. Since the US attacked on Feb. 28, US benchmark West Texas Intermediate crude futures are up nearly 50%. The price tumbled from a multiyear on April 8 following the ceasefire announcement but have resumed rising.

The oil price surge walloped the bond market, both by driving up inflation expectations and via the logic that the Fed is unlikely to cut interest rates — even in response to signs of weakness in the US labor market — against a backdrop of quickening inflation.

“The CPI data today will not support bond prices as next month’s inflation report will reveal more headaches for investors and the Fed,” Tom di Galoma, managing director at Mischler Financial Group, said.

The CPI rose 3.3% from a year earlier, the fastest pace in nearly two years. Fed policymakers have a 2% “longer-run” target for a different measure of inflation. That measure rose 3% from a year earlier in February and will be reported for March on April 30, the day after the central bank’s next scheduled rate decision.

The consumer sentiment slump — a preliminary finding for April — reflected the expectation that inflation will be 4.8% over the next year. The US national average retail price for regular unleaded gasoline topped $4 a gallon at the end of March, up from under $3 at the end of February.

Monthly Loss

Rising yields in the Treasury market in March produced its biggest monthly loss in more than a year.

Before the war started traders were pricing in at least two quarter-point rate reductions by the Fed in 2026. As oil prices rose, they scrapped that view and briefly wagered that the Fed’s next move would be a rate increase. More recently, the potential for mounting energy prices to put the brakes on the economy has partially restored wagers on a cut this year.

Short-maturity Treasuries, whose yields are most closely tied to Fed policy, are likely to “remain more volatile” as traders price in “the potential inflation impact and the probability of a Fed cut — or even a hike,” said Anders Persson, chief investment officer and head of global fixed income at Nuveen.

The US two-year yield, which ended February at 3.37%, rose at least 10 basis points in a day four times in March. Since peaking at 4.02% on March 27, it fell five basis points in a day three times. It rose Friday to 3.80%. The Fed’s rate target band has been 3.5% to 3.75% since December.

The ceasefire agreed to by US President Donald Trump remained broadly intact Friday, though the Strait of Hormuz was still effectively shut. The US and Iran are scheduled for direct talks in Pakistan over the weekend. Nuveen’s Persson said the uncertainty warrants a cautious approach to longer-term bonds, and favors those that mature in three to seven years.

Growth Risks

By contrast, Dan Carter, senior portfolio manager at Fort Washington Investment Advisors, said the risks to economic growth favor risk-taking in bonds, hedged with inflation-protected securities.

The CPI report “data doesn’t suggest any worrisome inflation pressures outside of energy,” and “the economy won’t be strong enough to generate cyclical inflation pressures,” Carter said.

Stronger-than-expected March US employment data released last week soothed growth worries. The Fed cut interest rates three times last year in response to weakness in the job market, then paused the cuts, citing improvement on that front.

Minutes from their March meeting, released this week, revealed that a growing contingent of officials was concerned that the war would contribute to rising inflation.

The March CPI report is the last major economic data release before Fed policymakers’ April 29 rate decision, and their self-imposed communications blackout period ahead of the meeting begins April 18.

–With assistance from Ye Xie and Miles J. Herszenhorn.

(Updates yield levels.)

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