There's a tug of war going on in the U.S. Treasury market right now

The Treasury market saw a violent burst of buying Thursday as traders had second thoughts on Federal Reserve rate hikes in 2026

Good news on the economy early Thursday appeared to be more bad news for the battered U.S. Treasury market.

Yet as the turbulent session wore on, intense buying suddenly erupted in policy-sensitive parts of the $31.5 trillion Treasury market. Even longer-dated securities rallied day after yields hit their highest levels since 2002.

One catalyst appeared to be a repricing of rate-hike expectations following earlier comments from several Federal Reserve speakers, including New York Fed President John Williams, who suggested that additional hikes might wait.

That pulled the odds of an October hike down to 26% on Thursday, from closer to 70% a week ago, according to the CME FedWatch Tool.

The could mean the Fed increases rates only twice this year in total, instead of the three times many traders previously expected. The yield on the policy-sensitive 2-year Treasury BX:TMUBMUSD02Y plunged as much as 11 basis points Thursday to 4.76%, before giving back some of the rally, according to FactSet. Bond yields move in the opposite direction of prices.

Minneapolis Fed President Neel Kashkari told Bloomberg Television on Thursday that he's closely watching the gap between the 2-year Treasury yield and the slightly more-than-4% rate implied by the Fed's own "median dot" forecast for the path of interest rates.

"So, I actually think markets are pretty good when they want to send the signal, they will send the signal, regardless of what the Fed is telling them," Kashkari said.

A day earlier, Kashkari said he penciled in one more rate hike in 2026 and another one next year.

Another potential factor that improved appetite for U.S. Treasury debt was tumult out of Europe.

Heavy selling in European government bonds has been spilling over lately into U.S. government debt. But that eased a bit Thursday as European markets were closing, helping the 30-year U.K. yield BX:TMBMKGB-30Y pull back from 6%, while the 30-year French yield BX:TMBMKFR-30Y fell from 5.6%, according to FactSet.

Long 30-year bonds around the world tend to be highly sensitive to inflation expectations. Given growing public-debt levels, Brent crude prices (BRN00) back above $100 a barrel and the enduring Iran war, it's no surprise those yields remain near multidecade highs.

Inflation and growth expectations also play a role in the all-important 10-year Treasury yield BX:TMUBMUSD10Y, which initially gained as much as 4 basis points to 5.31% after Thursday's economic-data releases, but abruptly fell to about 5.23% by the session's end.

Manufacturing data for September came in at a four-month high, even as inflation from fuel and tariffs remains a problem. Weekly jobless claims also were steady, while jobs cuts in September were their lowest since 2022, according to data from Challenger, Gray & Christmas.

"It's all pointing in the same direction," said Mike Lorizio, head of U.S. rates and mortgage trading at Manulife Investment Management. "The economy is accelerating," he added.

Yet with the labor market looking steady, there's also anxiety around where the Fed might ultimately need to bring rates to tame inflation.

"The Fed is surely not restrictive here," said Lorizio.

Inflation pegged at a 3.4% annual rate this week was better than anticipated, but still not good enough, especially when Fed officials are trying to prove their commitment to get it down to 2%, said Dustin Reid, chief fixed-income strategist at Mackenzie Investments.

Furthermore, the U.S. economy has remained far more resilient than many expected, in no small part because of the artificial-intelligence spending boom that's also pushing up the cost of capital.

"That requires a repricing at the back end of the Treasury yield curve," said Reid.

Yet the 10-year Treasury yield has surged about 127 basis points since the Iran war began in late February, while the 30-year yield was up 97 basis points over the same stretch, according to Dow Jones Market Data.

Reid said the spike in yields already triggered levels that could prompt additional steps from the Trump administration or Treasury Department that aim to keep yields in check.

"I wouldn't be surprised to see additional measures," he said, noting that each week is getting closer to the November midterm elections.

-Joy Wiltermuth -Greg Robb