Renewed hostilities between the United States and Iran unsettled energy markets in July, even as domestic data painted a more encouraging picture of the economy. Crude prices retreated from their near-term peak after diplomatic overtures eased fears of a prolonged closure of the Strait of Hormuz, though the conflict continues to fuel market volatility. Inflation cooled meaningfully in June after the recent run-up tied to tariffs and conflict-related uncertainty. Growth slowed from the first quarter’s pace, while hiring continued at a moderated clip. The Chandler team continues to expect the Federal Reserve to hold the federal funds rate steady through the remainder of 2026, provided actual and market-based measures of inflation remain contained.
The Federal Open Market Committee held the federal funds rate at 3.50% to 3.75% during its July 28 to 29 meeting, extending its policy pause into a fifth consecutive gathering. Three regional Reserve Bank presidents, Cleveland’s Beth Hammack, Minneapolis’s Neel Kashkari, and Dallas’s Lorie Logan, dissented in favor of raising rates by a quarter point, citing inflation that has stayed above target for more than five years. Chair Kevin Warsh, in his second meeting leading the Committee, again declined to offer explicit forward guidance, preferring instead to let incoming data dictate the timing of any future move. The balance sheet runoff continued without modification. Officials next convene September 15 to 16.
Treasury yields advanced across the curve in July, with the two-year note ending the month at 4.29%, the five-year at 4.45%, and the ten-year at 4.74%. The two-year to ten-year spread narrowed to 45 basis points from 69 basis points at year end, while the three-month bill to ten-year spread widened to roughly 97 basis points. Because the two-year yield rose more than the ten-year yield over the year to date, the curve has flattened rather than steepened, a shift driven by growing expectations that the Federal Reserve may need to raise rates rather than cut before year end. The two-year to ten-year spread has averaged near 95 basis points since 2005, underscoring how compressed the relationship between short and long maturities remains relative to that longer run norm.
The Treasury curve remained positively sloped across its full tenor range through the end of July. The spread between the three-month bill and the 10-year note widened to 97 basis points, while the closely watched two-year/10-year spread widened to 45 basis points after reaching a June low of 24 basis points. That divergence suggests the recent rise in yields has been concentrated in the short and intermediate maturities rather than lifting the curve uniformly. The curve’s overall shape continues to signal that markets view a near-term recession as unlikely, even as uncertainty around the Fed’s next move has increased since the July meeting. Bond market volatility also rose steadily throughout the month, with the MOVE index ending July at its highest level since the May spike. Higher volatility may persist under Chair Warsh until investors gain greater clarity on the Fed’s reaction function under his leadership.