From Tariffs to Tensions: Why Interest Rates Keep Changing

One of the beneficiaries of last year’s labor market weakness was a decline in the 10-year Treasury yield. When the economy begins to weaken, investors often shift toward the safety of U.S. Treasury securities. As demand for Treasuries rises, their prices increase and yields decline. Because the 10-year Treasury yield heavily influences mortgage rates and many consumer loans, lower Treasury yields are often followed by lower borrowing costs for households.

At the beginning of 2025, the 10-year Treasury yield had climbed to nearly 4.8%. Investors were pricing in stronger economic growth driven by expectations of deregulation and a more business-friendly policy environment. Thirty-year mortgage rates approached 7%.

Then came Liberation Day on April 2. By that point, the 10-year yield had fallen to roughly 4.0%. However, uncertainty surrounding tariffs and their potential inflationary effects quickly reversed that trend. By July 2025, the 10-year yield had climbed back toward 4.5%.

That uncertainty eventually showed up in the labor market. Hiring slowed dramatically as businesses delayed investment and expansion decisions. By year-end, 2025 had become one of the weakest years for job creation in more than two decades outside of a recession. As labor market conditions softened, the 10-year Treasury yield declined once again, falling back to around 4.0%, and mortgage rates followed. By March 2026, the average 30-year mortgage rate had eased to around 6.2%.

The conflict with Iran, which began in early 2026, quickly altered the outlook. Energy prices moved higher, pushing the Consumer Price Index upward to 4.2%. As inflation expectations increased, the 10-year Treasury yield rose to approximately 4.5% by June, while 30-year mortgage rates increased to about 6.6%.

Markets briefly received some relief following the ceasefire agreement. Treasury yields eased modestly to roughly 4.4%, and mortgage rates declined to approximately 6.4%.

More recently, renewed tensions and the breakdown of the ceasefire have pushed oil prices back toward the $100-per-barrel range. Treasury yields and mortgage rates have reversed course once again, with the 10-year Treasury yield now hitting 4.7% and 30-year mortgage rates climbing back to roughly 6.7%.

The latest inflation report, however, offered some encouraging news. Headline CPI fell 0.4% on a month-over-month basis, largely reflecting the sharp decline in energy prices following the ceasefire memorandum of understanding. The improvement was not limited to energy. Core inflation, which excludes food and energy prices, was flat for the month, while the year-over-year core CPI rate declined from 2.9% to 2.6%.

These shifting conditions have changed expectations for Federal Reserve policy. While some market participants have discussed the possibility of another rate increase, such a move appears unlikely at this point. The first half of 2026 produced stronger hiring than the exceptionally weak pace seen in 2025, but the most recent employment report was disappointing. Job growth came in well below expectations, while both employment and labor force participation declined. One month does not establish a trend, but renewed uncertainty surrounding tariffs could once again weigh on business investment and hiring.

The most recent Fed meeting was a hold, but the bond market reacted quite negatively as perceptions of Fed Chair Warsh’s commitment to fighting inflation worsened.

It is also worth noting that much of the economy’s recent strength has been concentrated in a few areas. Without continued investment in artificial intelligence and steady hiring in healthcare, overall GDP growth would have been considerably weaker, and the national conversation might be centered on job losses rather than job gains. 2nd quarter GDP out last week showed the economy softened.

Despite recent geopolitical developments and surge in bond yields, financial markets continue to expect inflation to remain relatively well contained over the longer run. Five-year market-based inflation expectations remain near 2.3%. Assuming geopolitical tensions ease and energy prices stabilize, inflation should continue moving lower, providing the Federal Reserve with additional room to leave interest rates unchanged this year. Continued masking of the economy behind AI and healthcare might even provide the Fed with ammunition for a 4th quarter cut.