Oil Drives Rise in Long-Term Yields as Iran War Escalates
The recent rise in long-term bond yields has been attributed to various factors, but one explanation stands out as the primary driver: oil prices. The escalating US-Iran conflict has pushed Brent crude above $100 a barrel for the first time since July, and this has had a direct impact on the 10-year Treasury yield, which has climbed above 4.8%, its highest level since 2023.
The key transmission mechanism is inflation. When oil prices rise, it feeds into gasoline, diesel, transportation, and production costs, causing investors to worry that inflation will remain higher for longer without a central bank's response. This matters greatly for long-duration bonds, as investors demand a higher yield to compensate for the loss of purchasing power and greater uncertainty around future interest rates.
The relationship between oil and long-term yields is particularly relevant in this context. The Iran war has increased the risk of further disruption through the Strait of Hormuz, which normally carries roughly a fifth of global oil and gas supplies. This has led to physical oil prices surging as buyers compete for alternative barrels.
The Treasury's buyback programme has been mentioned, but it is not the primary explanation for the broader move in yields. The program aims to repurchase up to $6 billion of longer-dated debt to improve liquidity and support the long end of the curve. However, this announcement disappointed expectations, as there were talks of $10 billion or even $12 billion buybacks.