Oil, bond yields soar on Middle East turmoil and rates anguish

Commonwealth Bank predicted that Brent crude could exceed $US100 a barrel should Iran be drawn into the conflict “more directly”. Qantas will raise airfares to mitigate the pressure on margins from higher jet fuel, it said on Friday.

Brent crude was trading at $US93.33 a barrel and West Texas Intermediate $US90.78, advancing around 1 per cent in the Asia session.

The US 10-year bond yield briefly topped 5 per cent, a level last seen in 2007.

“At 5 per cent, it is a compelling investment, particularly if we do have a recession – and the curve is telling you that we are,” said Angus Coote, co-founder of Jamieson Coote Bonds.

Breaking point

The gap between yields on two- and 10-year US Treasuries remains in negative territory at 17.1 basis points. When the curve inverts, which happens when short-term borrowing rates exceed long-term rates, it is an indicator of a looming recession. The two-year yield, which reflects interest rate expectations, eased 6 basis points to 5.16 per cent.

The bond fund manager said a downturn would be a consequence of rates staying at such elevated levels. “History tells you that when you hike this quickly, something typically breaks,” Mr Coote said. He remarked that companies have a lot of debt expiring in late 2024 and 2025, which will need to be refinanced.

“When you roll off into those higher interest rates, that’s when real problems happen,” he said, highlighting the doubling of US bankruptcies from a year ago.

This week, US drugstore chain Rite Aid filed for bankruptcy protection.

The acceleration of the bond sell-off came after Mr Powell discussed the prospect of more rate increases to suppress inflation, as the economy appears to withstand the 5 percentage points of monetary tightening since last year.

“We are attentive to recent data showing the resilience of economic growth and demand for labour. Additional evidence of persistently above-trend growth, or that tightness in the labour market is no longer easing, could put further progress on inflation at risk and could warrant further tightening of monetary policy,” the Fed boss said at the Economic Club of New York.

Fresh data this week highlighted strong consumer demand and factory production in a stubbornly tight job market. The number of Americans filing new claims for unemployment benefits fell to a nine-month low last week.

Instability

Futures traders are nearly certain the Fed keeps interest rates at the current range of 5.5 per cent to 5.75 per cent at its policy meeting in November. They slightly reduced the chance of an increase by year-end to 26 per cent chance, from 41 per cent on Thursday.

They also halved the number of rate cuts anticipated for 2024, fully pricing the first easing in July.

Mr Powell noted the long-term bond sell-off could lessen the need for further increases if it persisted. Fuelling the bond rout are growing concerns about the US government’s increasing deficit spending, stickiness in inflation, and war.

The conflict will affect commodities unevenly.

“The one commodity that we do have some reservations on is iron ore and that’s just because of the bursting of the bubble in Chinese property and that could weigh on iron ore prices over the next few years,” Regal’s Mr King said.

Regal favours energy commodities, uranium, copper, and many of the critical minerals that will be needed in the energy transition.

Meanwhile, the Cboe Volatility Index, known as Wall Street’s fear gauge, jumped to its highest closing level since March.

“The fact that there was little pullback in bond yields in the past 48 hours – despite the S&P 500 Index slipping over 2 per cent and the VIX Index closing at over 21 for the first time since March – is very disconcerting,” said Alvin Tan, head of Asia FX strategy at TD Securities.