(Bloomberg) -- The worst-case scenario of a further escalation in the conflict between the U.S. and Iran appears to have been averted for now, but the relief sell-off in haven assets may drive Treasury yields only so high.
The haven trade drove the 10-year U.S. benchmark yield as much as 11 basis points lower during Asia trading Wednesday after Iran fired a volley of missiles on U.S.-Iraqi airbases, in retaliation for an American airstrike that killed a top Iranian general. That flight-to-safety move gave way to a sell-off on hopes of a de-escalation, and President Donald Trump’s announcement in the U.S. morning of further sanctions, but no military action, pushed the benchmark to this week’s high, of 1.86%.
“It didn’t sound to me like there was any further escalation or expected retaliation so I think on net that should be seen as a positive,” said Mark Cabana, head of U.S. rates strategy at Bank of America Corp (NYSE:BAC).
But he still advocates a tactical approach to trading Treasuries for now, with the 10-year likely to stay within its recent ranges as geopolitical tensions persist.
“Even though these comments are somewhat conciliatory, it may not end here,” he said.
The round-trip in yields is fresh evidence of how geopolitical events have counteracted the upward pressure on rates from a brighter U.S. growth outlook. Wednesday brought solid labor data, as a report showed companies added more jobs last month than forecast, ahead of what’s expected to be a healthy payrolls report from the government Friday. That follows Tuesday figures indicating stronger-than-forecast expansion in the U.S. service sector.
Adding to pressure in favor of higher U.S. yields is the recent improvement in Chinese manufacturing data, suggesting global growth may have troughed. The yuan this week reached the strongest level since August.
There’s also a slate of U.S. government debt auctions to absorb. The Treasury will sell $24 billion of 10-year notes at 1 p.m. Washington time, with 30-year bonds ahead Thursday.
In Cabana’s view, a series of catalysts need to line up to set U.S. benchmark yields on an upward trend: further strength in U.S. and global growth and a pickup in inflation. In the meantime, he sees the trade-off between economic and geopolitical developments keeping yields lower.
“These are all reasonable things to anticipate over time, but at present I’d say at least in the market’s mind the balance of risks is skewed to the downside.”
(Updates with the U.S. president’s response, analyst comments.)