This week has basically revolved around two questions for broader markets. The first being can oil prices keep below $100? And the second being can 10-year Treasury yields stay below the 5% mark?
Today, we are starting to get an answer to both. And by the looks of it, neither is going in the direction that markets would have preferred.
Brent crude is back above $102 after a push higher in overnight trading, while 10-year Treasury yields have broken through 5% to hit 5.11% – the highest since 2007. And the moves here definitely did not go unnoticed. Stocks fell in Wall Street, with the S&P 500 dropping by 0.8% and the Nasdaq falling by 1.1%.
Earlier this week, I argued that the important thing wasn’t simply whether Brent crude could trade below $100 but whether it could actually stay there. The brief drop into the high-$90s was centered around hopes of US-Iran diplomacy for the most part, helping to take some of the geopolitical premium out of crude. But that optimism is looking considerably more fragile now.
There has been little tangible progress between the US and Iran, with Tehran maintaining their stance that it would not allow free passage through the Strait of Hormuz while US sanctions and the blockade remain in place. And until there is a genuine improvement in physical flows through the strait, it remains difficult for the oil market to confidently price out supply risk.
It is essentially the kind of risk highlighted when Brent crude first slipped back below $100. That being a situation where encouraging headlines can knock the geopolitical premium lower very quickly, but it can come back just as fast when the underlying supply problem hasn’t really gone away.
While this is going on, the move in Treasury yields is perhaps even more interesting for broader markets. That makes it no longer just an oil story.
Earlier this week, I asked the question of what catalyst might finally force 10-year yields decisively through 5%. Well, it seems like we’re already getting an answer to that one.
The US flash PMI report for September came in much hotter than expected, with the composite reading jumping from 56.0 to 58.4 – the strongest reading since July 2021. Adding to that, input costs also accelerated to almost a four-year high.
Then, there was also a poor $70 billion five-year Treasury auction, which cleared at 5.033% with a 3.1 bps tail and a softer 2.21 bid-to-cover ratio.
So when you put together stronger growth, sticky inflation, higher oil prices and shaky bond demand, you have a fairly uncomfortable combination for Treasuries.
Chart: A firm break above 5% now brings 10-year yields to the highest since 2007, inviting focus to the 5.25% to 5.30% region next.
This is where the two stories start feeding into one another.
Higher oil prices keep the inflation debate well and truly alive. And that gives the Fed less room to sound relaxed about price pressures, while stronger economic data makes it harder for the bond market to argue that restrictive policy is about to seriously weaken demand.
For stocks, that quickly removes two of the cushions that had helped risk sentiment earlier this week.
There is quite a difference between equities absorbing yields near 5% and having to deal with them moving towards 5.25% while Brent crude is simultaneously nudging back above $100. The former proved tolerable for a while, with AI optimism doing the heavy lifting while oil prices were cooling. However, that trade becomes harder when both pressure points are moving against stocks at once. Higher yields increase the discount rate on future earnings and borrowing costs, while higher oil threatens inflation and household purchasing power.
As such, I would say that the pain points for markets look fairly clear at this stage.
We spent the first half of this week asking whether oil prices could stay below $100 and yields below 5%. Now, the question has turned to whether or not markets can comfortably live with both being above them at the same time.
This article was written by Justin Low at investinglive.com.