Monthly Interest Rate Update
Interest rates continued their upward march in June, even as oil prices retreated following the reopening of the Strait of Hormuz. Persistent inflation, ongoing supply disruptions, and shifting expectations for Federal Reserve policy are reinforcing the market’s higher-for-longer rate outlook. Meanwhile, new Fed Chair Kevin Warsh struck a notably hawkish tone and announced a broad review of key Fed policies.
Rates stay higher as oil normalizes, jobs weaken
Interest rates were broadly higher this month, even as oil prices fell in response to the reopening of the Strait of Hormuz:
- The benchmark 10-year Treasury yield was up slightly in June, while 2-year yields jumped by 17 basis points. Two-year yields are now near their highest point of the year, up 65 basis points year-to-date; the 10-year is up a more modest 30 basis points. The resulting flattening of the yield curve reflects a shift in market expectations for Federal Reserve policy since February, when the US launched its attack on Iran and oil prices spiked in response.
- Crude oil prices have dropped to $73 per barrel, down dramatically from their April peak of $118. While this is good news for consumers, prices at the pump are still 21% above year-ago levels, contributing to 4.2% annual inflation (CPI). Even factoring out volatile food and energy prices, core PCE inflation was 3.4% last month, well above the Federal Reserve’s 2.0% target.
- Shipping volume remains below pre-war levels due to continuing concerns over vessel and crew safety as well as Iran’s ongoing attempts to control traffic flow through the critical energy supply lane. It will take time for physical supply to recover, not only because of the backlog, but also due to damage to oil infrastructure throughout the Middle East and long term efforts of oil producers in the region to build out alternative supply routes to reduce their dependence on Hormuz.
- Higher rates have persisted despite the truce in the Middle East. This is driven not only by the lingering effects of the Iran war, but the cumulative inflationary impact of higher energy costs, the sharp increase in tariffs, the rapid build-out of AI infrastructure, and constraints on global chip capacity.
The Fed left rates unchanged at their June 17 policy meeting. At his first FOMC meeting as Fed Chair, Kevin Warsh reassured markets of his commitment to fighting inflation and his independence from the White House. Overall, the committee members signaled a “hawkish hold,” suggesting that the Fed funds rate will trend flat to higher over the coming year. Warsh also announced that he will be forming task forces of inside and outside experts to consider changes in five broad areas of Fed policy and operations:
- Communications: Review the Fed’s forecasting and forward guidance, as well as the frequency of press conferences and public remarks by the regional Fed presidents.
- Balance Sheet: Clarify policy around quantitative easing and tightening.
- Economic Data: Review the sources and quality of economic data used by the Fed in setting rates.
- Jobs and Productivity: Study how (and whether) AI is reshaping employment and productivity.
- Inflation Frameworks: Reassess how inflation is measured and managed by the Fed.
Warsh has been a longtime critic of the Fed in these areas, preferring less transparency, a smaller balance sheet and use of a broader range of economic and inflation signals beyond government statistics. He signaled his communication preferences at the June meeting by significantly shortening the Fed’s post-meeting policy statement. He also declined to provide a dot for the quarterly “dot plot” forecast.
The market has adjusted to the new information. Futures traders are now pricing in a 78% of one or more rate hikes within the next year and a 97% chance that short-term rates will be unchanged or higher a year from now. The forward curve points to a modest uptick in long-term rates. Looking across the maturity spectrum, three to five year rates are now the low point of the yield curve.
Key Statistics: Interest Rates, Unemployment and Inflation
| Year-end 2022 | Year-end 2023 | Year-end 2024 | Year-end 2025 | June 30, 2026 | |
|---|---|---|---|---|---|
| 10-yr Treasury yield | 3.87% | 3.88% | 4.57% | 4.17% | 4.47% |
| 2-yr Treasury yield | 4.43% | 4.25% | 4.24% | 3.47% | 4.17% |
| Spread | -0.56% | -0.37% | 0.33% | 0.70% | 0.30% |
| Fed Funds Target (mid) | 4.375% | 5.375% | 4.375% | 3.625% | 3.625% |
| CME Term SOFR 1-mo | 4.36% | 5.35% | 4.33% | 3.69% | 3.65% |
| CPI (y/y change) | 6.5% | 3.1% | 2.7% | 2.7% | 4.2% |
| Core PCE (monthly) | 4.7% | 3.16% | 2.81% | 2.83% | 3.4% |
| 5-yr TIPS (market breakeven) | 2.38% | 2.15% | 2.39% | 2.27% | 2.27% |
| U-3 Unemployment | 3.5% | 3.7% | 4.1% | 4.4% | 4.2% |
| Real avg weekly earnings | -3.1% | 0.5% | 1.0% | 1.1% | -0.5% |
| Annual change in NFP jobs | +4,503,000 | +2,560,000 | +1,450,000 | +371,000 | +442,000 |
Interest rates continue rising as oil falls
Source: Bloomberg Finance LP
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Treasury yields had been closely tracking oil prices for much of the last nine months but began to diverge in May. Two-year rates (red above) continued their upward trajectory, even as 10-year yields (blue) eased off their peaks and Brent crude oil (white) saw a steep drop.
Source: Bloomberg Finance LP
- The labor market seemed to have bottomed out in April with a strong rebound in May, but June figures came out at a weaker-than expected 57,000 net new jobs and a downward revision of prior months. Leisure and hospitality jobs dropped, bucking normal summer seasonal hiring trends.
- Health care and social services remained strong, while sectors most affected by Artificial Intelligence, such as technology and finance, have softened.
- The unemployment rate ticked down to 4.2%. Real weekly earnings fell 0.5%.
Associated Bank offers a wide range of instruments for hedging interest rate, commodity and foreign currency risk, including foreign exchange in more than 75 currencies. Companies interested in learning more about these instruments should contact their Associated Bank Relationship Banker or the bank’s Capital Markets Department at 866-524-8836.
All rates shown are indications only and subject to change.
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