- U.S.-Israeli strike on Iran escalates Middle East conflict.
- Brent crude jumps 14%, briefly surpassing $80.
- Ten-year Treasury yield falls toward 3.90% Monday.
- Investors weigh safe-haven demand against inflation risks.
The investors of U.S Treasury went into the month of March with their best performance of the month in a year. In days, increasing war in the Middle East reversed that tide plunging bond markets in the starkest dilemma of geopolitical fear: either a safe-haven rally or the galloping oil prices will revive inflation and unravel Federal Reserve rate-cuts expectations. The U.S. and Israeli attack on Iran on the weekend whereby Supreme Leader Ayatollah Ali Khamenei was killed was a strong escalation in the tensions in the region.
Brent crude had even proceeded past the $70 per barrel level in the weeks before the attack, whereas the demand to purchase U.S government bonds had driven the 10-year Treasury yield below 4%. Both actions, according to Reuters, surged into early trading on Monday. Brent crude shot as high as 14 percent, making a short run above the $80 per barrel movement due to fears of supply interference of the most vital arbiter of energy in the globe.
Concurrently, the 10-year Treasury yield plunged to 3.90, its lowest point since April, investors scramled into assets perceived to be safe. The buying spurt that was there at first turned cold. The market was able to recover yields at intraday lows, especially at the short end of the curve. Two-year Treasury yield changed its direction and traded 6 basis points up, indicating growing worries that rising energy prices would change the trend of the U.S. monetary policy.
The most important question facing bond investors is whether the stagflation equation will be dominated by either side. Increasing global risk in the geopolitical scenario and declining global equities, among other things, indicate, on the one hand, that Treasuries should be demanded. In the opposite, an unremitting rise in oil prices poses the risk of pushing inflation upwards, making the Federal Reserve dissolve or even undo projected reduction in rates.
Safe-Haven Demand Sold to Oil Shock
The equity markets of the world responded very quickly to the eruption of the hostilities. The majority of the major benchmark Asian and European indexes declined by 1-2 percent on Monday, supporting the attractiveness of high-rated sovereign bonds. The preliminary decline in European government yields occurred due to the fact that capital was flowing to safety.
A high demand for treasuries whenever there is a geopolitical shock is not new. Government debt of the U.S. is commonly used by investors who want to hedge risk-asset volatility and perceive it as a liquid and comparatively safe asset. The beginning of the week witnessed the sudden fall of the 10-year yield, which was an indicator of that historic trend. However, a counterforce came about soon in the energy markets.
Oil prices have been increased by about $20 per barrel in the last 6 weeks. Jordan Rochester at Mizuho puts it at around 10 to 20 basis points of growth in the world minus a long-term increase of 10-per-barrel. Should the price of crude escalate to $100 or so per barrel and stay that way, the pull back on economic activity may increase significantly. The inflation implications are also very important. Economists project that a permanent increase of oil by 10 increments translates into 0.2 percentage point per annum U.S. inflation.
As the Federal Reserve desired rate of inflation is already close to 3 percent and is starting to rise further, even minor ones present a challenge to the policy calculation of the central bank. Rabobank analysts observed that at much greater oil prices are inflationary that it was at the time Russia invaded Ukraine. The comparison highlights how fast the push and pull of prices through energy can cause a change of expectations within the fixed-income markets.
Policy Path in Question
Current statistics have already demonstrated a new price movement momentum. The producer-price inflation data of January released last week was hotter than they had previously thought. In the meantime, the year-on-year value of Brent crude has changed towards a positive position, being the first since mid-2024 since the phase of disinflationary base effects changed to inflationary base effects.
In the very beginning of January, Brent was approximately 30 percent less expensive than it was a year ago. It now costs 13 percent higher than it did 12 months ago. Reuters also observes that this turnaround will fuel the inflation models that Federal Reserve officials pay close attention to. More than 9 percent of the U.S. consumer price index is comprised of energy and motor fuel.
Analysts estimate that sustained growth in oil at $100 per barrel might be equivalent to a 0.8 percent to 1.5 percent increase in headline CPI in case of a complete pass-through of the price at the gasoline pump. That impact could be increased by secondary effects such as increased transport, housing, and food expenditure. Mizuho in Rochester has cautioned that the possibility of rate reduction this year will most likely be eliminated because of long-term oil trading at the ranges of $100 to $130, and that the possibility may even cause a rate tightening when it comes to the mild rate cycle at the least.
This would turn around much of the confidence which has led Treasuries in the last month. It is already in the market expectations that the markets have already adjusted. Although futures markets had already been making their bets on easing of policy in the later part of this year, traders are currently re-examining the issue of whether the Fed will be able to afford to loosen financial aspects with the possible rise of energy-based inflation.
Neither the oil nor the treasuries have moved out of the extremes that it hit at the start of Monday which is indicative of the lumbar nature of the conflict and uncertainty in terms of how long it will last. Nevertheless, no basic conflict is cleared up. Long-lasting war that interferes with energy chains would most probably maintain oil price high reinforcing the inflation argument.
On the other hand, another damaging spell of decline in the growth or financial health of the entire world would revive the safe-haven flows to government bonds. In the context of geopolitical risk and inflation dynamics, the interdependence of the two to an investors operating in this environment has turned exceptionally acute.
The direction of the bond market is now not just dependent on what is happening in the currently domestic economy but also with what is happening just thousands of miles in one of the most strategically important regions in the world.
The Treasury investors are given less room to err with the current conflict going on and the management of the energy market responding to the conflict. The safe-haven demand or the anxiety about inflation that might finally win will decide whether the trend will continue in February with the rally or if it will be followed by a more violent operation of the U.S. bond market.
