Hot inflation data and the absence of anything to suggest that the chokehold Iran’s closure of the Strait of Hormuz has on global oil supplies will be lifted has sent global bond yields surging, tightening global financial conditions and adding to the financial pressures on governments, businesses and households.
On Friday, after Donald Trump’s summit meeting with Xi Jinping failed to produce a concrete offer of help from China to reopen the strait, the oil price bounced above $US110 a barrel and global bond yields spiked.
The global bond market is the world’s most important, and yields are rising worldwide. In the US, the two-year yield was 3.38 per cent and the 10-year yield, 3.94 per cent on February 27, the eve of the US and Israeli assault on Iran. Now they are 4.07 per cent and 4.59 per cent respectively. The 30-year yield, at 5.12 per cent, is the highest it has been since mid-2007, just ahead of the global financial crisis.
The yields on German bonds have similarly jumped over the same period, with two-year yields up 74 basis points and 10-year yields more than 50 basis points.
In the UK, the combination of the energy crunch and political dysfunction has produced even more dramatic movement.
Two-year yields have risen more than a full percentage point, 10-year yields are up 94 basis points, and, at 5.85 per cent, the 30-year yield is the highest since 1998 in the aftermath of the Asian Financial Crisis and, of course, amid an earlier bout of the UK’s recurring political instability.
In Japan, 10-year yields have risen 60 basis points, and the 30-year yield rose past 4 per cent for the first time, while in Australia, yields on two and 10-year bonds are up by 59 and 48 basis points respectively, with the 10-year yield trading above 5 per cent for the first time in about 15 years.
Energy prices are the common thread, with Iran’s stranglehold on the Strait of Hormuz the underlying cause.
With no end in sight to that closure, and the likelihood that supplies of oil and petroleum derivatives from the Persian Gulf will be constrained and under threat from Iran well into the future, there’s now a “higher for longer” narrative for both oil prices and inflation.
The current impact of the war has been seen in gasoline and diesel prices around the world, which are feeding into, not just household costs, but the cost of transport generally, which is now starting to bleed into the prices of goods.
In the US, where gasoline prices are more than $US1.30 a gallon and diesel more than $US2 a gallon above their levels a year ago, consumer price inflation just hit 3.8 per cent and wholesale inflation 6 per cent, which was a significant element of the backdrop to the end-of-week surge in bond yields.
Those bond yields, particularly the 10-year yields, are more significant than central bank policy rates in determining what consumers, businesses and governments actually pay to borrow and are therefore raising the price of money, tightening financial conditions and lowering economic growth in economies around the world.
That impact is of particular significance for the US, where US government gross debt is on track to exceed $US40 trillion ($56 trillion) within months.
With an annual interest bill the Congressional Budget Office has said will top $US1 trillion this year, it will add billions to US federal deficits and debt levels that have been exploding.
The impact will be exaggerated by the refinancing strategy the US Treasury has been pursuing, where it has increasingly been borrowing short-term and rolling over maturing debt with more short-term debt.
With more than $US9 trillion of government debt maturing this year, the rise in bond yields will flow through to a substantial portion of the debt and, if sustained, add more than $US250 billion to interest costs.
It could get worse. With bond yields surging in Japan too, for the longer-duration bonds, at unprecedented levels, it will create incentives to unravel one of the longest and largest carry trades over the past 30 years: the exporting of Japanese savings to take advantage of higher rates elsewhere, but particularly those in the US.
A significant reversal of those flows, as Japanese institutions and individuals repatriate their funds, would add volatility and cost – higher yields – to the US market for government bonds.
Higher inflation rates inevitably mean higher central bank policy rates, which set the benchmarks against which short-term market rates are priced.
Pity Kevin Warsh, who is about to take up his role as the new Trump-nominated chairman of the US Federal Reserve, with a brief from the president to lower US rates significantly.
He could now find himself forced to risk Trump’s ire and raise rates in the face of a spiralling inflation rate caused by Trump’s unilateral decision (with some prodding from Israel) to wage war on Iran and the continuing effects of his trade war on the rest of the world.
Trump’s tariffs, alone, caused the US inflation rate to remain above the Fed’s 2 per cent target rate even before the war began. It’s generally estimated to have added about 0.8 to 0.9 of a percentage point to US inflation, while having a detrimental effect on economic growth rates around the world.
Bond investors – the “bond vigilantes” – have been largely out of the limelight in recent years as the US sharemarket has boomed, thanks to the massive investments occurring within the artificial intelligence sector and near-incredible returns built into the share prices of those companies at the centre of the AI boom.
Ultimately, however, the bond market can derail the sharemarket by raising the cost of finance for companies, including an AI sector increasingly looking to debt markets to help finance its extraordinary capital requirements.
The US sharemarket is trading at 27 times historical earnings and more than 22 times prospective earnings, well above their averages over the past decade of about 20 and 18 times, respectively. Valuations have been stretched by the hyper-optimism generated by the AI boom, so the market is vulnerable.
Global sharemarkets wobbled on Friday after it became apparent that Trump had left the meeting with Xi with a disappointingly small order for Boeing aircraft, some promises to buy more US soybeans and some level of agreement about establishing joint boards of trade and investment – but no commitment from Xi to use China’s strong relationship with Iran to reopen the strait.
With Trump and his advisers apparently clueless as to how to get Iran to reopen the strait without them, and America, being completely humiliated in the process, the current likelihood is that oil prices will remain high and might track significantly higher as the oil that was on the water before the crisis is used up and the strategic reserves that were unlocked to help dampen the price rises are depleted.
The prospect of higher gasoline and diesel prices and inflation doesn’t seem to unduly worry Trump, who notoriously said last week that the economic hardship Americans were feeling wouldn’t motivate him to end the war – “not even a little bit,” he said, adding that “I don’t think about Americans’ financial situation.”
He might not think about the impact of his military adventures and his tariffs on ordinary Americans, or the global economy and other governments and their citizens, but US companies, politicians and the voters at this year’s midterm elections increasingly will – as might sharemarket investors in the US and around the world if the rise in bond yields continues and blows up their markets in the process.
The Market Recap newsletter is a wrap of the day’s trading. Get it each weekday afternoon.
Stephen Bartholomeusz is one of Australia’s most respected business journalists. He was most recently co-founder and associate editor of the Business Spectator website and an associate editor and senior columnist at The Australian.Connect via email.
