• Treasury yields and the dollar edged higher as rising oil prices fueled inflation concerns amid stalled U.S.-Iran negotiations over the Strait of Hormuz.
  • Markets are now pricing in a greater chance of a Federal Reserve rate hike in September, ahead of Wednesday's key inflation report.
  • The 10-year Treasury yield climbed to 4.727%, while the dollar index (DXY) gained 0.1% to 99.851.

Rising Oil Prices Keep Pressure on Bonds and Buck

The bond market and the dollar are moving in tandem as oil’s upward march intensifies worries about inflation. With diplomatic efforts between Washington and Tehran showing little progress, the specter of supply disruptions in the Strait of Hormuz—a chokepoint for about a fifth of global oil consumption—has traders bracing for sustained energy costs.

Yield on the benchmark 10-year Treasury note rose to 4.727% in early trading, reflecting a selloff in fixed income as investors recalibrate their Fed expectations. Simultaneously, the dollar index extended its gains, up 0.1% to 99.851, as safe-haven flows and interest rate differentials continue to attract buyers.

Fed Rate Hike Bets Intensify

Money markets now show a higher probability of a rate increase at the Federal Reserve's September meeting, a swift reversal from just a few weeks ago when a cut was the base case. The shift underscores how much the rally in crude is complicating the central bank's fight against inflation.

According to analysts, the upcoming U.S. consumer price index report on Wednesday will be pivotal. A hotter-than-expected print could seal the deal for a hike, while a cooler number might temper the recent hawkish repricing.

"The market is on edge," said one fixed-income strategist. "Oil at these levels, if sustained, could keep inflation sticky and force the Fed's hand."

Geopolitics Take Center Stage

Negotiations between U.S. and Iranian officials over maritime security in the Strait of Hormuz appear to have hit a snag, with no breakthrough reported. The stalemate has kept a risk premium in oil prices, which have climbed over $83 a barrel for Brent crude.

"Without a diplomatic resolution, we could see further upward pressure on energy prices, which would feed directly into inflation expectations," noted a currency analyst.

In the currency market, the dollar's resilience is also tied to its status as a haven, with investors seeking shelter from geopolitical uncertainty. The yen, typically a safe haven, is weaker, highlighting the dollar's dominance.

What to Watch

All eyes now turn to Wednesday's inflation data. Economists surveyed expect headline CPI to rise 0.2% month-over-month, but the risk is to the upside given the recent spike in oil.

If inflation beats expectations, look for the 10-year yield to test the 4.8% level and the DXY to push toward 100. Conversely, a soft reading could trigger a relief rally in bonds and a pullback in the dollar.

Traders are also monitoring any headlines from the Middle East; even hints of progress in talks could unwind some of the recent moves.

Editor's Note: This story has been updated to reflect new trading data as of 10:45 a.m. ET.