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Oil prices have remained around $100 a barrel, a level that is increasingly threatening to reignite inflation concerns and push up borrowing costs. As bond markets track oil’s moves, mortgage rates and other long-term interest rates have followed higher.
Bond markets, which help set mortgage rates and other long-term borrowing costs, are trading in line with oil as it swings above or below $100 a barrel. When investors believe the Iran conflict is ending, oil prices and interest rates tend to fall together. When investors expect the war to drag on, yields rise.
That dynamic has helped lift the yield on the 10-year U.S. Treasury to 4.47% on Wednesday, up from below 4% before the war. The average 30-year mortgage rate has also increased to 6.37%, rising from below 6% in late February.
Bond investors’ central concern is that inflation could erode the real value of their interest payments. To compensate for that risk, investors have been demanding higher yields on government bonds.
Higher oil prices are therefore feeding through to higher borrowing costs for households and businesses. The article notes that this could delay home purchases and investment decisions.
It is not only U.S. borrowing costs that are moving. Bond yields are also up in Germany, the United Kingdom, Canada and Australia, according to Bob Elliott, CEO and chief investment officer at Unlimited Funds.
Analysts at ING said the Federal Reserve cannot cut rates “here,” citing the inflation risks tied to higher oil prices. For now, the 10-year yield may remain below the 4.5% threshold, since earning around that level is described as a “structural buy for many players.” However, the same analysts cautioned that yields could move higher if price pressures do not ease.
Other expectations for rate cuts later in the year remain in view. The article cites that the consumer price index rose by 3.8% in April, while UBS analysts expect inflation to moderate to 3.3% by year-end, which they say could support continued Fed cuts.
UBS also highlighted a second channel: higher oil prices could depress economic activity, strengthening the case for Fed cuts to help prevent unemployment from rising. The analysts said the market still underestimates the downside risks to growth, adding that while higher oil prices may mechanically lift inflation expectations in the near term, they are likely to weigh on economic activity over time.
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