Rising Interest Rates vs Crude Oil Prices: A Complex Relationship

The recent increase in interest rates on Treasury bonds seems counterintuitive given the decline in oil prices. However, according to economic analysis, an increase in interest rates should lead to a decrease in crude oil prices. The correlation between annual average yields on 10-year and 30-year Treasury bonds and West Texas Intermediate (WTI) crude oil prices is -0.70, meaning that a one-unit change in interest rates is associated with a 0.7-unit change in the opposite direction of crude oil prices.

The consumption of crude oil is 'intertemporally substitutable,' meaning that it can be produced and consumed during the current time period or in a future one. Market forces determine the allocation of resources over time, leading to an increase in interest rates resulting in a short-term decline in the price of crude oil.

The common assumption that increases in oil prices are 'inflationary' is incorrect. Inflation is a monetary phenomenon caused by growth in the nominal supply of money greater than growth in real demand. A change in oil prices is a change in relative prices, inducing a shift of resources across sectors and resulting in recessionary effects rather than inflationary ones.

The recent war has increased uncertainty about international security conditions, leading to higher interest rates. However, the fundamental principle remains valid: crude oil prices fall when interest rates rise.