Bond Yields Hit Multiyear Highs as Iran Conflict Fuels Inflation Fears
The 30-year Treasury yield climbed to 5.58 percent Monday, its highest level since 2002. That number sticks in your head. It should.
The 30-year Treasury yield climbed to 5.58 percent Monday, its highest level since 2002. That number sticks in your head. It should. Borrowing costs for mortgages, corporate debt, and government spending all trace back to these yields. When they move this fast, things break.
The bond-market selloff shows few signs of easing. Yields on 10- and 30-year Treasury notes hit multiyear highs Monday. Investors are increasingly concerned a prolonged Iran conflict could keep energy prices elevated. This could complicate the inflation outlook and force the Fed to raise rates more aggressively.
I have seen this pattern before. Not the Iran part. The part where bond traders wake up and realize inflation is not going back to two percent on schedule. Energy prices move first. Then everything else follows. Oil jumped above $120 per barrel earlier this year when the Strait of Hormuz closed. It has come down since. But six-month Brent futures sit above $80 per barrel now. That tells you the market expects this to last.
Seema Shah, chief global strategist at Principal Asset Management, put it plainly in a LinkedIn post. She wrote that “oil prices stay high, raising broader inflation risk.” That is the whole story in nine words.
What the Fed is facing
The Federal Reserve raised rates in mid-September for the first time in three years. The target range now sits at 3.75 to 4.00 percent. Fed Chair Kevin Warsh called inflation a choice of the central bank. He said it is too high and has been for too long. The updated projections show 16 of 18 policymakers expect at least one more quarter-point hike by year-end.
Bond yields do not care about projections. They care about what inflation actually does. Each $10 per barrel increase in oil prices reduces GDP growth by 0.1 percentage point and raises headline inflation by 0.3 percentage point after four quarters. That math comes from Principal Asset Management’s analysis of the Iran conflict. At higher price levels, the effects become non-linear. Risks to both growth and inflation widen.
The 10-year Treasury yield reached 5.27 percent Monday. That is the highest since June 2007. The 30-year touched 5.58 percent, a level last seen in 2002. These are not small moves. A basis point is one hundredth of a percent. When yields jump 10 or 15 basis points in a day, someone is getting hurt.
What this means for borrowing
Higher yields push up the cost of borrowing for consumers, businesses, and governments alike. Mortgage rates track the 10-year note. Corporate treasurers price new debt off these benchmarks. The US Treasury Department drew very weak demand for a $70 billion five-year note auction last week. The notes sold at the highest yield at an auction since 2007.
Equity markets continue to price a short conflict with limited economic fallout. Bond markets are bracing for a longer lasting inflation shock. That divergence matters. Stock investors can exit fast. Bond investors cannot. They hold duration. They feel every basis point.
I remember 2004. The 30-year yield sat around 5.5 percent then. Growth looked solid. Inflation looked contained. Then it was not. I remember 2007. The 10-year yield hit 5.2 percent. Housing looked strong. Credit looked cheap. Then the mortgage market cracked.
This is not that. Not yet. But the pattern rhymes. Energy prices rise first. Inflation follows with a lag. The Fed reacts late. Yields overshoot. Something breaks. Usually it is the thing everyone said was too big to fail.
The stalemate between the US and Iran surrounding the terms of reopening the Strait of Hormuz continues. A growing number of tankers are crossing the waterway. But the risk premium stays. Six-month futures tell you that. They price in conflict that lasts quarters, not weeks.
A severe adverse scenario would mean a multi-quarter closure of the Strait of Hormuz. That could drive oil sustainably above $125 per barrel. It would knock around 0.5 to 1 percent off baseline GDP forecasts. Core inflation could push above 3.5 percent by year-end. That would force the Fed to consider rate hikes beyond what policymakers currently project.
Nobody knows if that happens. The market is pricing the risk. That is what bond yields do. They tell you what investors fear, not what will occur. Right now they fear higher inflation. They fear the Fed will have to raise rates more aggressively than expected. They fear energy prices will not come down fast enough.
Treasury yields fell slightly Tuesday as oil prices turned lower. But they remained close to multiyear highs. The 10-year yield sat at 5.22 percent. The 30-year at 5.54 percent. These levels could attract investors as fixed income becomes increasingly competitive with equities. That is what Richard Hunter at Interactive Investor said. He may be right. Or he may be early.
I count the money twice. I always have. Yields at these levels look attractive on paper. But attractive does not mean safe. Safe means you know what inflation will do. Nobody knows that. Not the Fed. Not Principal Asset Management. Not me.
The bond-market selloff is showing few signs of easing. That is the fact. The rest is guesswork dressed up as analysis. I have spent thirty years watching markets. The ones who last are the ones who admit what they do not know.