Investors are shunning U.S. debt as a haven play during the Iran conflict
The 10-year Treasury yield had its biggest two-week rise since last April. – MarketWatch photo illustration/iStockphoto The conflict with Iran is producing a somewhat counterintuitive reaction in the roughly $30 trillion U.S. bond market, by sending the benchmark 10-year yield to its steepest two-week climb in almost a year. Military conflicts traditionally prompt investors to…
The 10-year Treasury yield had its biggest two-week rise since last April. – MarketWatch photo illustration/iStockphoto
The conflict with Iran is producing a somewhat counterintuitive reaction in the roughly $30 trillion U.S. bond market, by sending the benchmark 10-year yield to its steepest two-week climb in almost a year.
Military conflicts traditionally prompt investors to seek the safety of Treasurys, which then results in lower yields. But that’s not always the case when a geopolitical crisis is also pushing up inflation expectations, as it is now. A combination of higher oil prices, a federal deficit that’s likely to be exacerbated by wartime spending, and a U.S. central bank that may not be able to cut borrowing costs as much as expected this year are all altering the equation.
Ordinarily, the long-dated yield’s moves ought to be notably lagging those of the policy-sensitive 2-year rate after an oil supply shock, as traders price in the near-term risks of higher inflation and tighter policy from the Federal Reserve while reducing long-term growth expectations. That’s still happening, but by a far less degree than expected.
Investors have been shunning U.S. debt as a haven play, pushing yields on the 2-year Treasury note, the 10-year note BX:TMUBMUSD10Y, and the 30-year bond BX:TMUBMUSD30Y into steep climbs since late February. That’s putting more financial pressure on households and businesses than before the U.S. and Israel began to launch airstrikes against Iran on Feb. 28.
The 10-year yield, which influences the cost of borrowing on everything from auto and student loans to new 30-year fixed mortgages and corporate debt, has jumped 32 basis points to 4.28% as of Friday, from 3.96% in late February. That’s the biggest two-week rise since the period that ended on April 17 of last year, based on preliminary data from Dow Jones Market Data. The 30-year yield also had its biggest two-week increase in nearly a year after advancing 27.5 basis points to almost 4.91%.
Meanwhile, the 2-year yield BX:TMUBMUSD02Y has risen 35.5 basis points to 3.73% from roughly 3.38% over the same two-week period — a difference of just 3.2 basis points from the 10-year yield’s moves.
The extent of the 10-year yield’s rise in March “runs against conventional wisdom,” said Deutsche Bank strategist Steven Zeng in a phone interview on Friday. He said the reason the 10-year yield can’t go down by as much as previously assumed is because of concerns about more deficit spending by the U.S. government, which is driving up term premium, or the extra compensation investors demand for holding long-term Treasury maturities. In addition, “the economic backdrop of high inflation before the war started plays into it, amplifying worries about inflation coming back.”
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While concerns about elevated U.S. inflation and deficit spending existed before the war against Iran, they are now being intensified by the military conflict. As of Friday, inflation traders were braced for the consumer-price index’s annual headline rate to be at or above 3% through next February. Meanwhile, Pentagon officials told members of Congress earlier this week that the estimated cost of the war was $11.3 billion in the first six days, according to the New York Times, citing people familiar with the briefing.
David Morrison, a London-based senior market analyst at financial-services provider Trade Nation, said “it’s worth noting that Treasury yields did fall sharply in the immediate aftermath of the initial attack on Iran. But if this was a ‘flight to safety’ trade, there was little conviction behind it. Why? Most likely because investors are preparing for the inflationary effects of higher energy prices.”
On Friday, Brent crude BRN00, the global benchmark for oil prices, was back above $100 a barrel. All three major U.S. stock indexes DJIA SPX COMP finished lower, while 10- through 30-year Treasury yields ended slightly higher. Data released earlier in the session showed that prices rose briskly in January based on the Fed’s favored inflation gauge, the personal-consumption expenditures index. Price gains are also on track to increase sharply in February.
The 10-year yield’s jump this month boils down to the fact that “inflation was already picking up before the U.S./Israeli attack on Iran, so the jump in the oil price may have simply exacerbated that move,” Morrison of Trade Nation said in an email to MarketWatch.
He noted that higher term premium for long-dated Treasury notes and bonds, along with the prospect of more U.S. government debt issuance, underscore why there’s been such a sharp rise in yields — which has also pushed mortgage rates back above 6% and “will only dampen activity in the housing market.”
In a note published on Friday, Deutsche Bank’s Zeng and other strategists cited all the reasons they think the 10-year yield has moved higher over the past two weeks. They said the biggest factor, which has contributed to more than half of the 10-year yield’s climb, is the rise in secured overnight financing rates stemming from higher inflation expectations. SOFR is a benchmark rate used to price derivatives, such as interest-rate swaps.
Ultimately, the bulk of the reasoning behind recent moves “is due to an oil price shock leading to inflation worries, forcing the Fed to stay on hold” with interest rates, Zeng said.
