Bond traders are backing off Fed rate hike bets — here's what it means for mortgage rates

If oil is about to spark an inflation wave, the bond market hasn't heard about it.

Brent crude ( BZ=F ) is trading around $112 a barrel, more than 50% higher than before the Iran war began in late February. Normally, that kind of spike would have bond investors worried about inflation and pushing interest rates higher.

Instead, Treasurys are rallying on Thursday as stocks slide. The 10-year Treasury yield ( ^TNX ) is on track for its biggest one-day drop in more than two years, slipping back below 5%. When bond prices rise, yields fall. That matters for anyone shopping for a home, because mortgage rates tend to follow the 10-year .

Behind the move is a quick change of heart about the Federal Reserve as long-term interest rates decline. The Fed meets next week, on Oct. 28, and investors have been bracing for it to raise rates to fight perceived oil-driven inflation.

Those bets are fading fast. Fed funds futures now put the odds of an October hike at about 5%, according to Bloomberg data. That's down from 15% on Wednesday and 37% at the end of September.

The outlook for December has shifted too. As recently as Wednesday, traders were fully priced for a hike by year-end. Now they see roughly a 75% chance.

Why bond traders aren't panicking about oil

Even with oil soaring, the bond market's inflation forecast has barely budged.

One way to measure what investors expect is the gap between regular Treasurys and Treasury Inflation-Protected Securities, or TIPS , which pay extra when prices rise. That gap, called the breakeven rate , says investors expect inflation to average about 2.4% a year over the next five years. That's the same as before the war started.

So why did yields climb so much this year? Almost all of it came from "real" yields, which is what bonds pay after inflation. That's a bet the Fed will keep rates high enough to stop oil from turning into lasting inflation, not a bet that inflation is about to take off.

Not everyone buys the market's calm. Bloomberg strategist Simon White argues breakevens are "mispricing" the oil shock.

The average 30-year fixed mortgage rate fell to 7.32% this week from 7.40%, according to Freddie Mac. That's the first drop in two months, after a seven-week climb that took rates to their highest level since 2023. Before the war, rates were just under 6%.

Freddie Mac's survey doesn't capture Thursday's bond rally. If yields stay lower, mortgage rates could follow in the coming days.