Oil price spike behind long-term yield jump, not other factors

Many factors are blamed for the increase in long-term bond yields, but a straightforward reason is overlooked: the rise in yields is primarily due to oil prices, which are climbing because of the war with Iran.

As tensions between the US and Iran worsened, Brent crude moved back above $100 per barrel. The 10-year Treasury yield also rose above 4.8%, a level not seen since 2023.

Oil goes up, yields follow

Inflation is the main transmission channel. Oil price shocks affect more than just energy. Crude price increases impact gasoline, diesel, transport and production expenses. Should the shock continue, investors fear prolonged higher inflation, particularly in the absence of a central bank response.

This is highly significant for long-duration bonds. A worsening inflation outlook leads investors to seek higher yields to offset reduced purchasing power and increased uncertainty about interest rates.

Thus, the link between oil and long-term yields currently outweighs many other headlines that seek attention or fit the price moves.

The Iran war is the common denominator

In today's environment, oil and bonds tell the same tale. The Iran conflict's escalation raises the risk of extended disruption at the Strait of Hormuz. The waterway typically handles about one-fifth of global oil and gas shipments.

On Wednesday, Brent settled above $100 for the first time since July. Physical crude prices also climbed as buyers vied for other barrels. Dated Brent reached $114.26 on September 9, according to S&P Global, underscoring the tightness in the physical market.

This is the bond market's role. Should the conflict drive oil up, the inflation outlook must be reconsidered. Higher inflation expectations could alter monetary policy views. Even if the Fed disregards a temporary energy shock, the market must account for the risk of persistence, exerting upward pressure on long-term yields.

What about the Treasury buyback?

The Treasury's buyback programme matters but does not primarily explain the broader yield move. Up to $6 billion of longer-dated debt is to be repurchased by the Treasury, as announced, aiming to boost liquidity and support the long end. However, the 10-year yield kept rising to 2023 highs. That was partly due to the announcement falling short of expectations — talk of $10 billion or $12 billion buybacks had circulated — but inflation worries are the real driver.

The buyback can affect bond market mechanics but cannot eliminate $100 oil. Long-term yields are increasing worldwide, and the only solutions are either central bank tightening, which might lead to a recession, or a resolution of the Iran war.

Currently, oil is the key indicator. All other factors are merely noise.