U.S. President Bill Clinton’s key political adviser, James Carville, once said that if he did believe in reincarnation he wouldn’t come back as a world or religious leader, or even a great Major League Baseball player.
“I would like to come back as the bond market,” he said. “You can intimidate everybody.”
There’s certainly an element of that in the recent surge higher in U.S. Treasury yields and government bond markets around the world. The start of the war with Iran in late February has stoked global crude prices and triggered a fresh round of inflation angst.
Bond markets have since pushed interest rates higher, played a hand in lifting inflation expectations to multi-year peaks, and reminded investors that the underlying fiscal mechanics of the world’s biggest economy—and its debt pile of nearly $40 trillion—are anything but sound.
Recent moves also have intimidated the stock market as longer-dated Treasury yields approached levels last seen in 2007 and an index of global bond yields traded at the highest levels since 2008, according to Bloomberg.
U.S. stocks, in fact, have fallen nearly 2% over the past three sessions, including the near 50-point slide for the S&P 500 as Treasury yields hit their recent selloff peak and news from the Gulf suggests peace with Iran, and by extension a re-opening of the Strait of Hormuz, remains a long way off.
“Bond markets remain nervous about the Iran war (which potentially impacts inflation and fiscal deficits),” said UBS Wealth Management’s chief global economist, Paul Donovan.
“Investors hope that market angst might encourage a U.S. policy shift, as it did with tariffs,” he added. “However, (at the time), tariffs were under President Trump’s direct control and could be changed on a whim. Middle Eastern politics is a little more complex.”
Benchmark 10-year Treasury note yields touched 4.67% on Tuesday, the highest in more than a year, while longer-dated 30-year bonds reached 5.18%, the highest since 2007.
Goldman Sachs, in fact, noted Tuesday that the two-month correlation between U.S. stocks and 10-year Treasury yields was now the most negative since the late 1990s.
And things might not start to improve anytime soon.
Global oil prices have been hovering near $110 a barrel as the war in Iran and the closure of the Strait of Hormuz moves well past 80 days with no real chance of a deal in sight.
Crude markets, in fact, see prices elevated near $90 a barrel well into the end of the year, lifting headline inflation readings and adding further “feedback loop” pressures to U.S. Treasuries.
A recent survey from the Federal Reserve Bank of Philadelphia, in fact, suggested slower growth and faster inflation over the coming year, with the headline consumer price index averaging 6%, a massive increase from the 2.7% forecast issued prior to the war with Iran.
Bond markets have taken notice.
“The combination of persistent inflation risks, elevated oil prices, and rising yields could challenge the bullish momentum that has carried equities toward recent highs and could fuel additional corrections,” said Paolo Broccardo, CEO at Bahamas-based BankPro. “Higher yields could increase pressure on equities as tighter financial conditions could weigh on valuations, particularly in growth sectors.”
Padhraic Garvery, ING’s regional head of Americas research, now sees an “overshoot risk” for 4.75% on the 10-year yield, with each day of no agreement on Hormuz offering Treasuries “a vacuum to trade into (and) logically, a test for even higher yields.”
It remains entirely conceivable that our mid-year forecast of the 4.5% area is very achievable, but for now we’re undeniably looking up in yield, and we remain in an overshoot tendency,” he said.
“We’ve marked 4.75% as our next staging post, but we still worry that an overshoot risk beyond that to 5% cannot be ruled out (the new uncomfortably high probability risk case),” he added. “The mood music rhymes with this.”
Other investors, including Ed Yardeni of Yardeni Research, think it’s too early to ”freak out” about the rise in Treasury yields just yet, given that the moves, he said Wednesday, are likely a response to faster-than-expected inflation readings tied to “a resilient economy with a short-term inflation problem.”
“The [Federal Reserve] should respond to the latter by raising the federal funds rate within the next two months,” he said. “Nevertheless, we expect that the economy and corporate earnings will remain resilient.”
“The bull market isn’t at risk of being derailed by the selloff in the bond market, which presents a very good opportunity to buy both bonds and stocks,” he added.
The final word will come from yields, of course, but Carville’s assessment, delivered in the early 1990s, remains sound.
Write to Martin Baccardax at martin.baccardax@barrons.com