The third quarter was a painful one for fixed income investors as government bond yields rose dramatically across developed markets. In the U.S., a confluence of factors drove yields higher across the curve - the commencement of a Fed hiking cycle under Chairman Warsh, a strong labor market, resilient domestic growth, and the ongoing conflict in Iran driving oil prices higher. Where does that leave us now? While bond market investors felt the pinch of negative total returns in the quarter due to higher yields, the relative attractiveness of bonds is the strongest in years.

Yields in the front end of the curve had to contend with a more hawkish Fed. While the Fed held rates steady in July, Chairman Warsh’s Jackson Hole speech in August pointed to a more protracted hiking cycle than the market had previously priced in. The Fed raised rates in the September meeting by 25 basis points, and the market now prices in at least one more hike by the end of 2026. The 2-year breakeven rate - the market-implied level of annualized inflation of the next two years - stands at 2.5% today, up from 2.0% at the beginning of the quarter. Oil isn’t helping. Benchmark crude oil prices soared in the third quarter. Brent crude rose from $73 a barrel to $103 a barrel, a 42% surge. Similarly, WTI rose 29% to end the quarter at $92 a barrel. Oil, Treasury yields, and inflation expectations were all highly correlated during the quarter. Headline CPI printed at 3.5% in June, 3.4% in July, and 3.4% in August, substantially higher than the Fed’s 2% target. Core CPI, which strips out the run higher in commodity prices, printed at 2.6%, 2.5%, and 2.4% over the same period. Warsh remains committed to reigning inflation back to the target.