Investors concerned about increasing bond yields may benefit from watching crude oil prices more closely than the Federal Reserve, an economist says.
The recent selloff in US government bonds has become closely linked to fluctuations in oil prices as the war in Iran heightens concerns that inflation could stay elevated, according to Steven Blitz, chief US economist at TS Lombard and GlobalData.
On Thursday morning, the benchmark 10-year US Treasury yield was trading above 5.1%, after reaching its highest level since the Global Financial Crisis the previous day.
The move followed weeks of bond selling driven by stubborn inflation, higher oil prices, substantial government borrowing and intensifying competition for capital.
“At this point, the 10-year is a bet on oil prices,” Blitz wrote in a Wednesday note.
Treasury yields are normally influenced by expectations for Federal Reserve action, inflation and the overall economic outlook. Blitz said oil has now become the more important market to monitor.
International Brent crude futures have risen roughly 40% since the US-Iran war began, fueling concern that costly energy could keep inflation high and leading investors to seek higher yields on long-term government debt.
According to Blitz’s analysis, every $1 change in West Texas Intermediate crude since 2012 has corresponded with an almost two-basis-point movement in the 10-year Treasury yield.
“Over the short term, this is a trade, not an investment,” he wrote about the 10-year Treasury.
The strain is not confined to the US.
Investors are also following Japan, where government bond yields have reached their highest point in decades as the Bank of Japan reverses years of highly accommodative monetary policy. This is making Japanese government debt more appealing to domestic investors, who have historically been among the largest foreign purchasers of US Treasurys.
On Thursday, Japan’s benchmark 10-year government bond yield traded at its highest level in 30 years, highlighting the worldwide increase in public borrowing costs.
Rising Treasury yields affect far more than Wall Street. They influence mortgage rates, auto loans, credit-card interest charges and the cost of borrowing for companies.
They may also weigh on stock valuations by giving investors a more rewarding return on comparatively safe government debt.
Even so, Blitz does not consider current yields sufficiently appealing.
For investors with a one-year outlook, he believes rolling investments in short-term Treasury bills may be preferable if the Fed continues to lift interest rates.
He also doubts that a 5% Treasury yield adequately pays investors for committing their money over the next decade.
“A 5% yield on the 10-year is just on the verge of becoming attractive, but it still fails to price in the built-in risks—especially rising inflation—and is not yet compelling enough to match the range of potential returns available from equities over the next 10 years,” he wrote.