(Bloomberg) -- Treasuries rose as oil prices retreated from multiyear highs, keeping alive the prospect of a Federal Reserve interest-rate cut this year to offset the economic consequences of the US war in Iran.

US government debt further pared its biggest monthly loss in more than a year. Treasury yields — which reached their highest levels in several months last week as the inflationary aspect of the oil price surge wiped out expectations for Fed interest-rate cuts this year — declined for a second straight day. They were lower by one to four basis points across maturities, with short-maturity tenors closest to the Fed’s rate falling the most.

“Oil at $90 a barrel is inflationary, and oil at $110 a barrel is recessionary,” said Bryce Doty, a bond fund manager at Sit Investment Associates. “The Fed’s decision is binary. When oil hovers around $90, the idea of a rate increase creeps into investors’ minds,” while at the higher level the Fed “would have to cut to offset the damage. The sentiment flips around this $100-a-barrel level,” where the US benchmark oil contract closed Monday for the first time since 2022.

The gains helped to push US two-year yields lower by three basis points to 3.79%, after falling eight basis points on Monday. However, they are still up more than 40 basis points since the war began and headed for the biggest monthly jump since October 2024. Their 10-year peers dropped two basis points to 4.32%, down from an eight-month high of 4.48% last week.

Treasury debt also is poised to benefit from calendar-driven trading on the final day of the month and first quarter. Monthly rebalancing of bond indexes to incorporate new securities created during the month and remove ones maturing in less than a year normally causes a trading volume surge as passive investors make adjustments to remain in sync with their indexes. Their buying may benefit the market if dealers have underestimated the scale of it. Bloomberg’s US Treasury index rebalances at 4 p.m. New York time.

Tuesday’s US economic data releases — including an unexpected increase in the Conference Board’s March consumer confidence gauge and February JOLTS job openings that declined in line with expectations, pointing to cooler labor demand before the start of the war — drew limited reaction from bond investors.

The drop in yields highlighted the shifting pattern in how bond investors view the more than 50% increase in oil benchmarks since the Feb. 28 start of the war in the Middle East. For most of the month, yields tracked the oil price based on its link to inflation gauges via gasoline.

The correlation snapped late last week as the threat to economic growth from rising energy prices gained traction, with Treasury yields declining even as oil rose further. Tuesday’s price action, though complicated by calendar-driven trading on the final day of the month and first quarter, saw yields resume tracking oil’s intraday course.

Oil prices whipsawed Tuesday, initially rising on news that an Iranian drone hit a fully laden Kuwaiti oil tanker off Dubai. They pared gains following a Wall Street Journal report President Donald Trump has told aides he’s willing to end the military campaign against Iran even if the Strait of Hormuz remains largely closed.

Traders are betting the Fed will hold rates steady in a 3.5% to 3.75% range this year, with a small chance of a quarter-point cut by the middle of 2027.

European bonds largely followed US peers higher, helped by data for the bloc that showed inflation rose 2.5% from a year ago in March, faster than the previous month’s pace but slower than expected among analysts polled by Bloomberg.

In the US, Fed Vice Chair for Supervision Michelle Bowman and Governor Michael Barr may offer clues on the path for rates when they speak later Tuesday. On Monday, Chair Jerome Powell said that longer-term inflation expectations appear to be in check, but that the central bank is carefully monitoring them as it assesses the effect from the war.

The Fed’s Austan Goolsbee and Jeff Schmid will also give speeches, but they don’t vote on monetary policy decisions this year.

“The market keeps veering from inflation fears — higher yields, — to slowdown fears — lower yields,” said Win Thin, chief economist at Bank of Nassau 1982 Ltd. “That’s the problem with stagflation, there is no easy policy response, and so I think markets are struggling to figure out which risk to focus on — the ‘stag’ part or the ‘flation’ part.”

--With assistance from David Finnerty.

(Adds US economic data releases and updates yield levels.)

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